Earnings Season: What to Expect

Susan Dziubinski: On your radar this week, Dave, is earnings season. Seems like we just finished with earnings, but here we are again. What are you expecting in this earnings season?

Dave Sekera: I think third-quarter earnings in and of themselves will generally be very strong. Management guidance last quarter probably shouldn’t be all that difficult to beat. And also the U.S. has just remained defiant in the face of tight monetary policy. So, economic growth has been much stronger than we had originally expected. In fact, if you look at our numbers here, we just recently updated our GDP forecast for the third quarter to 3.9%.

Dziubinski: Are there any sectors or industries in particular that maybe look more vulnerable or are more likely to show at least slowed growth?

Sekera: Well, as compared to the consensus estimates, I do think there’s a risk in the banking sector. Banking has been under pressure the past couple of quarters. Short-term funding costs have remained elevated. So, I think there’s probably a risk there. Across some of the other sectors, I’d say the media sector might be also at risk because of the writers’ strikes that we had. And of course the automakers, in light of the strikes from the UAW. And then lastly, probably the consumer defensive sector. While inflation, the rate is moderating, it’s still putting a lot of pressure on purchasing power, specifically for middle- and low-income households.

Dziubinski: What about forecasts, Dave? What are you expecting to hear from companies as far as their expectations, not just for the rest of this year but maybe into 2024?

Sekera: Well, I’m not sure if they’ll give us too much for 2024 yet. Maybe some body language but really no specifics. But the management guidance will be key as far as how that stock is going to trade here in the short term. When guidance is either higher or lower than what the market is expecting, you can certainly see a stock price get whipped around pretty quickly. However, I do want to caution investors, those short-term movements, they’re not always necessarily indicative of changes in the long-term intrinsic valuation of a company. So, I think investors always need to take a step back and really decipher why did that company beat or miss? Was it just a natural short-term variation in its business and that will end up normalizing pretty quickly? Or is it really a paradigm shift that needs to be incorporated into your long-term projections and your investment thesis?

Now this quarter, I expect that guidance, it’s going to be very idiosyncratic by company. And I think a quote from Warren Buffett is very apt for this situation. That quote being: A rising tide floats all boats, but it’s only when the tide goes out do you discover who’s been swimming naked. Now, of course, as we mentioned, the U.S. economy has been defiant in the face of tight monetary policy and high interest rates. And this rising tide has helped out a wide multitude of sectors and companies the past couple of quarters. But we do expect that the U.S. economy will start to slow, especially here in the fourth quarter and the next couple of quarters, thus the receding tide. So, we’ll see which companies will be able to successfully navigate the slowing economy versus those that end up running aground. And I suspect this quarter we’ll hear caution from companies in the most economically sensitive sectors. Those will be the ones that start to see this slowdown first and reduce guidance.

Dziubinski: You mentioned banks earlier in your comments, and we do have banks starting to report this week. What are you going to be watching for in those reports?

Sekera: Well, I read some reports and talked to our U.S. bank analyst Eric Compton, and he noted there’s really four main areas that he’s going to be watching closely this quarter.

The first is going to be guidance on net interest income. The net interest margins have been under a lot of pressure from those high short-term funding costs. So, I know he’s specifically listening for management guidance as far as when they think it’s going to start to improve. Our current expectation is there’s going to be at least another one, if not two, more quarters before we start to see that improvement.

Secondly, it’s going to be loan-loss reserves. He expects they’re going to be mostly stable, although some additional deterioration in commercial real estate. This is an area that I personally watch very closely. If reserves start increasing meaningfully, that does indicate that the banks might be starting to prepare for a recession.

Thirdly, it’s going to be deposit flows. Now it does appear the megabanks still appear to be losing deposits, but at this point, we expect that the deposit outflows from the regional banks are for the most part over.

And then lastly is interest-rate hedges. So, again, this is going to be more important to the regional banks than the megabanks, but we’re hoping that management hedged out at least some if not a large portion of their interest-rate risk. We did see interest rates head up over the third quarter, so we’re hoping that by hedging those out, both in their held-to-maturity account as well as their available-for-sale account, that that should put them in a better position than they otherwise would be in.

Dziubinski: Now, are there any particular banks that maybe look more vulnerable for one reason or another?

Sekera: As far as those that are at risk from a profitability point of view, Eric specifically pointed out Comerica CMA, KeyCorp KEY, and Zions ZION being the most at risk, in his mind.

This is an excerpt from this week’s episode of Monday Morning Markets with Morningstar’s Dave Sekera. Watch the full episode, 4 Stocks to Sell in 4Q 2023—And 4 Stocks to Buy Instead. View a list of previous episodes here.