The S&P 500, a leading indicator of the health and momentum of the U.S. stock market, is navigating turbulent waters. Recent data reveals an ebbing tide in its profitability, particularly when financial stocks are excluded. The decline from its zenith in the second quarter of 2022 is unmistakable. However, amid these shifting sands, certain sectors are bucking the trend, and the horizon might hold promise in the shape of a technological marvel: Artificial Intelligence (AI).
The S&P 500 ex-Financials’ trailing four-quarter return on equity (ROE) has dipped to 23.4%, a stark 176 basis points below its peak in Q2 2022. While the inclusion of financial stocks does paint a slightly rosier picture, the upswing in ROE from these sectors is significantly influenced by a surge in Berkshire Hathaway’s investment income. This year’s drag on profitability for S&P 500 ex-Financials is predominantly attributed to heightened interest expenses. A five-factor DuPont decomposition analysis reveals that of the 69 basis point contraction in ROE, a significant 31 basis points are due to surging interest expenses. Every sector felt the pinch, with Financials and Energy sectors bearing the brunt of this decline.
Yet, it’s not all gloom. Six of the eleven sectors in the S&P 500 have seen their ROE grow this year, with Consumer Discretionary leading the charge, boasting a 718 bp increase. The driving force behind this? A whopping 683 bp expansion in EBIT margins. Even with some sectors witnessing a dip in their ROE, a majority still hover above their historical averages. This deviation in sectoral performances presents an intricate tapestry of the current market dynamics. On the valuation front, while most sectors align closely with the valuations implied by their expected ROE, Info Tech, Consumer Discretionary, and Energy stand out. The former two, influenced significantly by tech giants like Apple, Amazon, and Tesla, trade above their Price/Book multiple due to heightened investor optimism around AI.
The future of the S&P 500 ex-Financials’ profitability remains uncertain. Projections suggest a stabilization by 2024 but hopes of a significant expansion are tepid at best. With the looming ‘higher for longer’ interest rates, increased borrowing costs, and the potential curtailment of leveraging, the landscape is set to evolve. Yet, amid these challenges, AI emerges as a beacon of potential, with predictions suggesting it could supercharge the S&P 500’s annual average EPS growth over the next two decades. Only time will tell if this digital dynamo can indeed reshape the contours of the stock market’s profitability landscape.
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The Hot Zones this Week
Each week there are zones where trading can get wild. I call these the hot zones.
Corporate Profits for 2Q 2023: Corporate profits for the second quarter of 2023 have been revised upward, with the estimate marked up by $365 billion or 13.0%. The year-over-year growth rate of corporate profits has been adjusted from an initial -6.5% to a revised -2.7%.
Savings Rate and Excess Savings: Recent revisions have shed light on changes in the saving rate. Downward adjustments were observed for the pre-pandemic period and the years 2020-22. However, for the first two quarters of this year, there was an upward revision. This has implications for the estimated excess savings, which now stands at approximately $1.1 trillion.
Business Investment in 2023: Revisions to GDP in previous years indicate a smaller downturn in 2020 than initially estimated, with a softer rebound in 2021 and 2022. For 2023, GDP growth for 1Q witnessed a slight upward revision, while 2Q remained consistent with previous estimates. Significant revisions were observed in structures and equipment, indicating a strong resurgence in business investment, possibly influenced by legislative acts like the CHIPS Act and the Inflation Reduction Act.
Inflation Revisions: Core PCE inflation for 2Q 2023 has been revised upward to 4.6% year-over-year, from the earlier estimate of 4.4%. The main drivers for this upward trend are services inflation and nondurable goods, with durable goods seeing a downward revision. This data suggests that the Federal Reserve might need to employ more stringent measures to align inflation with their targets.
Consumer Momentum in 2023: Significant downward revisions to real consumer spending for 1Q and 2Q of 2023 reveal weaker consumer momentum than initially anticipated. Challenges are expected in 4Q 2023, including the impact of rising energy prices and the resumption of student loan repayments.
US GDP Tracking for 3Q 2023: The 2Q US GDP for 2023 remains at 2.1% q/q saar, which is consistent with the second estimate but below the tracked estimate of 2.3% q/q saar. With weaker than expected consumer momentum and other factors in play, the GDP tracking estimate for 3Q 2023 has been adjusted downwards to 2.8%. Additionally, a variety of economic indicators will be released in the upcoming week, which might impact the GDP tracking. These include August construction spending, factory orders, trade balance, September vehicle sales, and the employment report.
Macro Market
Economic Calendar
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Briefing.com
Last Week’s Numbers
Review Last week’s numbers here.
Earnings
Source I/B/E/S data from Refinitiv
Aggregate Estimates and Revisions
- 23Q2 Y/Y earnings are expected to be -2.8%. Excluding the energy sector, the Y/Y earnings estimate is 3.6%.
- Of the 499 companies in the S&P 500 that have reported earnings to date for 23Q2, 78.8% have reported earnings above analyst estimates. This compares to a long-term average of 66.4% and prior four quarter average of 73.4%.
- During the week of October. 2, four S&P 500 companies are expected to report quarterly earnings.
Global Spotlight
Turkey’s Parliament is Back Turkey’s parliament is back to work on Oct. 1 after their summer break. They have lots of things to discuss like the country’s money issues and possible changes to the constitution. However, what’s making the biggest news is Sweden wanting to join NATO. Turkey’s leader, President Erdogan, said he wants the U.S. to say okay to selling new F-16 plane parts to Turkey first. But now, there’s a new problem. Ben Cardin, who’s a big deal in the U.S. Senate, wants to think about this deal because he’s worried about human rights.
Elections in Slovakia Slovakia is having elections on Sept. 30. This happened because the last government, led by Prime Minister Heger, had to step down in May after they lost a trust vote last December. Right now, polls say the Direction-Social Democracy party is in the lead with 20%, with Progressive Slovakia at 18% and Voice-Social Democracy at 13%. No matter who wins, it might take a long time for the parties to agree and form a government.
Big Meeting in Spain for European Leaders On Oct. 5, leaders from Europe are meeting in Granada, Spain. They will talk about big things, like responding to Russia taking over part of Ukraine and if more countries can join the EU. An important person, Charles Michel, said in August that the EU should be open to more members by 2030. There will also be a talk about if Georgia can join the EU in December. Also, the leaders of Armenia and Azerbaijan will meet, which is a big deal because they had a recent conflict. It might be a tough meeting.
Possible U.S. Government Shutdown The U.S. government might shut down on Oct. 1 if they don’t agree on their 2024 money plans. Even though the House is trying its best, it seems unlikely they will agree on time. If there’s a shutdown, some government workers won’t get paid. If this goes on for a long time, it can hurt the country’s economy. If they don’t decide by the end of the year, there will be automatic cuts in spending starting Jan. 1, 2024.
Stratfor.com
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