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Market Commentary: February 2023 – Leading the Runner

Leading the Runner

February 2023

By Jonathan McAdams, CFA

Football season has now drawn to a close (congrats Chiefs fans!). Like many Super Bowl fans, I was particularly gripped by the quarterback duel between two of the best in the league – marveling at how difficult their job is. They throw a ball upwards of 55 mph, to hit a receiver running 20 mph, inside a window no more than a foot wide. To do this, a quarterback doesn’t throw to where the receiver is, he throws to where the receiver is going to be. This is an apt analogy for how the stock market trades – it often doesn’t trade on what the news is right now, it trades on where the news is going to be in the future.

With a large portion of earnings reporting season now behind us, current news is not great. Pulte Homes (PHM), one of the largest national homebuilders, reported in their most recent quarter that orders were down 41% and their backlog was down 39%. But the stock is up 56% from its recent October low, and up 23% year to date. Lam Research (LRCX), a large semiconductor equipment manufacturer, reported that next quarter’s revenue growth would be down 6% and that the entire industry would be down over 20% in 2023. Yet the stock is up 61% from the October low, and up 20% year to date. Freeport McMoran (FCX) reported revenues down 6%, margins down 30%, and that full year costs would be 5% higher than last year. Yet the stock is up 68% off its lows, and up 11% year to date.

These companies are a microcosm of what is going on in the broad market. So far, the amount by which S&P 500 companies are beating sales and earnings estimates are well below their 10-year average. Q4 sales are up 4%, but earnings are down 5%, which means margins are contracting. All in, analysts are revising down their 2023 estimates at a blistering pace. Yet even with this earnings pressure, the market is up 16% from its October lows and up 6% year to date.


How is the market rallying in the face of such downward pressure on earnings? As mentioned earlier, it’s because the market is “throwing” to where the news is going to be, not to where it is. The market has already discounted much of the weakness we are seeing in current earnings reports, which helps explain some of why there were negative returns in the market last year – investors last year were looking ahead to today.

As we look forward from here, however, the recent rally doesn’t necessarily mean the economy is headed towards a recovery in the near future – growth could deteriorate, leading to a potential recession. As we’ve touched on in previous pieces, many leading economic indicators and surveys seem to be pointing toward recessionary conditions. But a Fed that looks relatively close to pausing rate hikes and a continued robust labor market could keep the economy from veering too far off its route.

Another looming risk is a potential political showdown over raising the debt ceiling limit. The setup for a debt limit crisis is eerily similar to the one in 2011 that resulted in a strong market pullback and a debt downgrade by Standard & Poor’s. So far, the market has taken the threat in stride, but as the deadline nears (likely by June as many are predicting), market angst could begin to build depending on how close to the brink both sides want to take it.

Offsetting these risks, China’s recent removal of COVID restrictions could have a significant positive effect on the economy as pent-up demand and easing of supply bottlenecks provide a ballast against wavering developed economies. We are already starting to see this positive impact on China-dependent commodities like steel and copper.

The future has many crosscurrents, but what we do know is that we need to keep our eyes down the field on where the economy and fundamentals are heading, instead of what the headlines say today. Not all economic “passes” will be completed. The market could still falter from here – receivers can run the wrong route (recession) or there may be a pass interference call (debt ceiling). But what we do know is that over the course of a season, the US economy, like all good quarterbacks, completes more passes than it misses – ultimately leading to a winning portfolio.

Shannon Dermody

Shannon DermodyTEST

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