The market has been a turbulent one so far in October. Despite the Federal Reserve's best attempt to bring down prices, the data released just 2 days ago shows that inflation came in at a whopping 8.2 percent which was significantly higher than expected, it is a sign that things might continue getting worse with another substantial rate hike plans less than three weeks away. However, what's even more concerning isn't that people are now hoarding cash at the highest level in 10 years, but instead the fact that inflation is still not going away with the reality that an even stronger dollar could trigger the next crisis.
With stock markets on a rollercoaster amid Federal Reserve rate hikes, recession fears, elevated inflation, and escalated tensions between Ukraine and Russia, investors will be looking towards Q3 earnings season for clues about the health of the US economy.
That being said, the US third-quarter earnings season is well underway, with major banks like $JPM (PMorgan Chase & Co), $C (Citigroup), $MS (Morgan Stanley) at the beginning of the list that have released their earnings for FY22 Q3 over the past week.
Citigroup managed to exceed expectations as its lending business benefited from the continuous interest rate hikes by the Fed and negated weaknesses in other divisions such as investment banking and trading. Banks in general, are seeing a bump in their net interest income after years of near-zero interest rates as the Fed tightens its monetary policy. However, the same aggressive move has sparked fears of a downturn in the economy that in turn stalled investment banking activity, roiled financial markets and prompted companies and households to put their borrowing plans on hold. Some key data for the quarter can be seen below:
Net interest income: Increased 18%
Revenue (investment banking): Reduced 64%
Revenue (markets division): Reduced 24%
The net interest income, otherwise known as the spread which banks charge between the cost of borrowing funds and lending them out, has increased mainly due to the interest rate hike by the Fed. While investment banking revenue has declined significantly as the market has not been reacting well to the interest rate hikes and the various crises at large. Note that this decline is more significant, because just last quarter (Q2), Citigroup had its best M&A quarter and the second-best investment banking quarter in a decade. Lastly, the revenue from their markets division, which includes fixed income and equity trading units, also fell due to more or less the same reasons.
For the Q3 earnings season, the outlook that companies give about their expectations for the future will be more important than the earnings they report. Forward guidance will be important given concerns around inflation and a weakening economy. Investors will be closely monitoring the impact of higher costs and companies' ability to pass on higher prices to customers to protect profit margins. Demand conditions and inventory levels will also be keenly watched. Slowing demand and bloated inventories often lead to retailers offering deep discounts to clear stock, which in turn affect profits.
On another note, the impact of the stronger dollar has manifested in ways one would expect. Many US companies with significant international operations could be impacted by the stronger US dollar. The rise of the dollar typically eats into the profits of such companies since they need to convert foreign currencies into US dollars.
Given that roughly 40% of S&P 500 revenues are generated internationally, we could see more companies report a negative impact to earnings due to currency fluctuations. This is supported by data from Factset estimates, where S&P 500 companies that generate the bulk of their revenues outside the US are expected to record a slight negative earnings growth.
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