With all the Fed fireworks in the market over the past week, investors might be forgiven for forgetting that third-quarter earnings season is already under way.
Yet individual corporate results may not offer much in the way of a reprieve, warns Bill McMahon, chief investment officer of Active Equity Strategies at Schwab Asset Management.
McMahon spoke with Barron’s about his outlook for stocks, and says that after all the focus on the macro backdrop, he is “looking forward to hearing from individual companies.”
That said, he isn’t necessarily anticipating a pain-free season.
“We do expect earnings expectations to come down,” he said, due to everything from a strong dollar weighing on multinational companies to the impact of ongoing inflation on margins.
Moreover, individual companies may be able to provide more reassuring updates on things such as supply chain and labor pressures that would be welcome to investors, but as already seen with bank earnings, there is plenty of room for companies even within the same sector to produce very different results.
Nor can companies hide between the bad-news-is-good-news rhetoric around the Federal Reserve.
“When you’re talking about individual companies, bad news is just bad news,” says McMahon. “With the Fed, people are looking for things like higher unemployment that could stay [its] hand,” but poor corporate earnings are unlikely to produce the same effect.
Nonetheless, he argues that bargain hunters, particularly those with a longer-term focus who can ride out a bit of near-term volatility, would do well put cash to work.
“We’re seeing a lot of value …it’s paradoxical, but when the macro backdrop is so poor, that’s when you find good values.”
There are few places where that may be truer than consumer discretionary, a sector that’s been slammed even harder than the broader market this year. Yet McMahon believes that despite higher inflation, consumers still seem inclined to spend, bolstered by some lingering pandemic savings.
He points to Nike, saying it is “akin to a luxury brand and very viable long term.” The company has had recent woes, stemming from high inventory and continued uncertainty about its growth in the key market of China. With shares off 47% year to date, it’s “for long-term investors, it’s a good place to be; but that’s not to say it’s not going to bounce around with the rest of the market.”
Speaking of that volatility, he believes that despite their relative outperformance, consumer staples still present an attractive place to hide. He points to Coca-Cola, aBarron’s favoritethat is facing meaningful foreign exchange headwinds, but nonetheless enjoys strong pricing power. “Even within staples you want to be in the higher quality companies [that can raise prices]; those on the more commodity-driven end will get squeezed.”
On the other end of the spectrum, McMahon remains overweight energy, despite the sector’s big run and what is likely to be some demand destruction from a weaker economy. He points to the recent announcement by OPEC and its allies to cut oil production quotas as just one factor hampering supply, providing ongoing support for the stocks. Exxon Mobil and Chevron are his picks.
He is also getting more interested in utilities, which until a recent selloff had been “priced to perfection,” and thus could present some opportunities around earnings volatility.
In the end, he thinks no matter the sector, investors need to be choosy and stay “within the quality spectrum” of companies that can power through a softer environment.
“This isn’t a time to go and buy the junkiest stocks you can find because they’re cheap,” he says.
To separate the wheat from the chaff he suggests companies that are more profitable than their peer group, generate a lot of free cash flow, and have stronger balance sheets that will minimize the need to borrow in the future, as interest rates look likely to stay higher.