Overview
The fourth quarter earnings season is underway, and early results show a tale of two economies. The tech sector is flexing strong growth, with companies like Microsoft, AMD, and Apple beating expectations. However, other sectors like industrials and materials are seeing negative or flat earnings growth overall.
Investor reactions to earnings have been muted so far, despite some big beats. This indicates concerns about slowing economic growth in 2023 amid high inflation and interest rates. However, bulls are hopeful that falling inflation could pave the way for Fed rate cuts later this year, spurring gains in stocks.
Standout Tech Results
Microsoft stock popped after reporting earnings, with Azure cloud revenue growth reaccelerating. AMD also beat and raised guidance significantly on data center and gaming chip demand. Apple reassured on iPhone demand in China despite production cuts. These tech giants helped lift S&P 500 earnings estimates recently.
| Company | Key Metric | Result vs. Estimate | Stock Reaction |
|---|---|---|---|
| Microsoft | Azure Revenue Growth | 31% beat | +7% |
| AMD | Q4 Revenue | $5.6B beat | +6% |
| Apple | China iPhone Demand | Reassuring | +3% |
Other tech winners included ServiceNow, Lam Research, and Texas Instruments. Their strong data center, semiconductor, and analog chip exposure is paying off.
Struggles in Industrials, Materials, Energy
Meanwhile, overall S&P 500 earnings growth outside of tech is negative. Materials and energy sector profits are down double digits with lower commodity prices. Industrial giants like Caterpillar and 3M face foreign currency headwinds, cost inflation, and slowing demand.
Banks like Goldman Sachs and Morgan Stanley are also seeing steep declines in investment banking and trading revenues. Higher rates help lending profits, but capital markets activity has dried up.
| Sector | Q4 Earnings Growth | Key Issues |
|---|
Materials | -14% | Falling Prices |
Energy | -10% | Lower Oil/Gas |
Industrials | -6% | FX, Costs, Demand |
Financials | -6% | IBanking, Trading |
This bifurcation between booming tech earnings and struggling cyclical sectors highlights macroeconomic uncertainties. The Fed’s rate hikes are working to slow demand, but risk recession if taken too far.
Fed Remains Hawkish for Now
The latest Fed meeting commentary indicates rates still need to move higher to get inflation fully under control. The Fed Funds rate is likely to exceed 5% this year before cuts materialize. This stance has kept markets on edge despite encouragement from earnings.
The Fed is laser focused on the strong labor market and wage growth. Rate cuts may not arrive until unemployment rises, suggesting more economic pain is needed for markets to find a bottom.
However, there is a bull case emerging for a soft landing based on recent data. Inflation improved notably in December across major categories:
| Category | Dec. Inflation | Peak |
|---|
Headline CPI | 6.5% | 9.1% |
Core CPI | 5.7% | 6.6% |
PCE Deflator | 5.0% | 7.3% |
Moderating price increases, along with supply chain improvements, could enable the Fed to pause rate hikes sooner than expected. This would limit recession odds and set up a recovery rally in stocks.
Market Reaction Muted Thus Far
Despite blockbuster growth from megacaps like Microsoft and Apple, the S&P 500 index has treaded water this earnings season. Stocks popped initially after those reports, but gave back gains on Fed jitters.
It seems clear that volatility will remain elevated until investors get more confirmation of “peak hawkishness” from the Fed. Trading will likely stay choppy for the next few months.
But there are some silver linings suggesting market bottoms could be near:
- Earnings estimates improving – After cuts through 2022, analysts are raising profit outlooks again
- Bearish sentiment spikes – Recent panic selling suggests capitulation is underway
- Valuations much lower – S&P 500 forward P/E compressed from 22X to 17X
These factors indicate stocks have largely priced in recession risk. The bar is set low for better economic data or dovish Fed surprises to drive upside.
UBS and Morgan Stanley strategists noted stocks are pricing in an “unrealistically severe recession”. Once clarity arrives that a soft landing is achievable, markets could stage a significant rally over the second half of 2023.
Key Things to Watch
As the Q4 earnings season continues, investors should watch for:
- Continued strength (or weakness) in mega-cap tech to drive markets
- Margin commentary from companies detailing inflation/cost trends
- Economic bellwethers like transports, semiconductors on demand signals
- Fed members interviewed to detect changes in tone
While uncertainty persists on the macro economic front, tech sector fundamentals appear solid. Software and semis are still seeing double-digit sales expansion against tough comps.
Apple’s ability to drive user growth and shrug off supply challenges is particularly bullish. Meanwhile, advertising and ecommerce giants like Google, Amazon, and Meta will be closely watched – but lower expectations could set up beats.
If the Fed indeed pauses rate hikes soon rather than crashing into a recession, tech and growth stocks would likely soar. That optimistic outcome now relies heavily on trends in inflation continuing to improve over the first half of 2023.
To err is human, but AI does it too. Whilst factual data is used in the production of these articles, the content is written entirely by AI. Double check any facts you intend to rely on with another source.
