How Will Inflation Impact Earnings?

How Will Inflation Impact Earnings?

How Will Inflation Impact Earnings?

The U.S. economy is growing, and it’s slowing. Today’s initial read on fourth-quarter GDP had something for everyone: It showed a U.S. economy that remains in growth mode—up 2.9% on an annualized basis—but is up just 1.0% over the past 12 months (the slowest pace in two years). In a period when recession fears are running wild, the news was better than expected and stock markets initially took it as a bullish sign.

This doesn’t indicate a recession later this year is off the table by any means, but it does reflect resilient consumerism in the face of higher prices and rising interest rates. And speaking of resilience, with just four trading days left in the month, stocks were on course for the best January in four years.

While inflation’s influence on Federal Reserve monetary policy remains an overarching theme on Wall Street, the current earnings-reporting season provides a concrete glimpse into how corporate profits have fared as interest rates have climbed—and, just as importantly, how business leaders are managing higher borrowing costs and consumers’ and businesses’ abilities to spend.

Here’s what we’re watching this week and why it matters:

  • Tech titan Microsoft posted its slowest quarterly sales growth since 2016 on the heels of announcing that it would cut 10,000 jobs. The move to shed payroll reflects a wider trend in the PC, software and cloud computing ecosystem as industry entrants respond to slower global growth by tightening up expenses that ran amok during the COVID-19 recovery period.
  • Other notable earnings reports revealed the following:
    • Railroad operators CSX, Norfolk Southern and Union Pacific all noted that their biggest customers, manufacturers, are experiencing reduced demand, while the transportation sector is facing higher labor and fuel costs, which may become obstacles to generating profits this year.
    • IT giant IBM posted flat fourth-quarter sales, largely because the U.S. dollar’s strength trimmed foreign revenues. It also joined the tech-layoff club with plans to cut 3,900 employees, about 1.5% of its workforce.
    • Aircraft manufacturer Boeing reported its fourth consecutive annual loss. The company grappled with higher production costs and parts shortages as the air-travel industry continues to recover from the pandemic slump.
  • The Conference Board’s Leading Economic Indicators index (LEI)—a compilation of 10 economic reads including building permits, manufacturers’ new orders, unemployment claims and consumer expectations—fell 1.0% in December and is down 7.4% since this time last year. The index is now at its lowest point since 2008’s financial crisis. The LEI has only dropped to these levels six times since the 1960s, and each of those times preceded a recession. But, so far, not this time…

Signal From Static: Inflation Roars Back (in the Discourse, That Is)

Chairman Dan Wiener

Inflation is rising, but not as measured by consumer or producer prices.

Pundits, and particularly those who misjudged inflation on the way up (or now on the way down), are arguing we need a different method for measuring it. It’s as if—because they couldn’t predict inflation accurately in years past—it’s the measure that must be wrong, not the predictions.

Inflation fears peaked shortly after June’s high-water mark of 9.1% (which declined to a 6.5% year-over-year rate by the end of 2022). But it feels as though the noise around inflation is still on the ascent.

Remember “transitory” inflation, the term Federal Reserve policymakers first used in March 2021? Their notion was that rising inflation would reverse quickly without much ado.

Along with many others, I thought the transitory theme was put to rest well before 2021 ended, as inflation rose from 2.6% to 7.0%. Not to mention that it kept rising in five of 2022’s first six months. Yet, in the past week or so, the notion of inflation as transitory has come back into the conversation. The argument is that you just have to look at the individual components of inflation to see which are transitory and which aren’t. What? That’s like saying a beef stew is low calorie if you focus solely on the celery and carrots.

The U.S. Labor Department’s two main measures of consumer inflation are the consumer price index (CPI) and the core consumer price index, which strips out food and energy prices in an effort to gauge inflation without the impact of these two more volatile components. The more recent parsing of the inflation data has also led to calls to focus on something called supercore inflation. Like core, supercore ignores food and energy prices while also stripping out housing, which is similarly volatile.

Difference between CPI and Core CPI
Note: Chart shows year-over-year changes in the consumer price index and core consumer price index (not seasonally adjusted) on a monthly basis from December 1999 through December 2022. Source: U.S. Bureau of Labor Statistics.

From where I sit, all the navel gazing on inflation is itself likely to be transitory. Whether the pundits think that transitory inflation elements or supercore prices or something else altogether might tell a more nuanced inflation story, the bottom line is that consumers, investors and even the U.S. government will continue to count on two long-standing measures: The CPI and the PCE (personal consumption expenditures index), which is the Fed’s “preferred” measure. Not some variant.

And right now, both government indexes say inflation is falling and should continue to do so. That’s the headline that matters most.

Chart of the Week: Can Foreign Currency Changes Boost Investment Returns?

Portfolio Manager Brett Miller

Foreign stocks are off to a roaring start in 2023, carrying momentum built during last year’s final weeks. Over the past three months, the MSCI All-Country World index ex-U.S., a measure of non-U.S. equities, has returned nearly 21%. By contrast, the S&P 500 has gained about 9%.

Wall Street has noticed: A recent Reuters poll of portfolio managers who oversee global strategies found that six out of 10 overweight foreign investments compared to their U.S. counterparts—the highest percentage since 2005.

After a decade of underperformance, is the stage being set for a sustained rally in overseas markets? We think so—in part because a weakening dollar is making foreign stocks more attractive than they’ve been in quite a long time.

Our chart of the week helps demonstrate the relationship between the dollar’s strength and the relative performance of U.S. and non-U.S. stocks. The blue line charts the relative performance of foreign stocks vs. U.S. stocks. When the line is rising, U.S. shares are performing better. The opposite is true when the line is dropping. You can see that the dashed line, representing the U.S. Dollar Index, moves in near correlation.

Over the past 25-plus years, a clear relationship has developed: As the dollar rises, U.S. markets outperform. In periods of dollar weakness, we can also observe the inverse—foreign stocks begin to outpace their counterparts.

Is a weaker dollar good for foreign stocks?
Note: Blue line traces the relative performance of U.S. stocks as measured by Vanguard’s Total Stock Market Index fund and of non-U.S. stocks as measured by Vanguard’s Total International Stock Index fund from April 1996 through November 2022. When the line rises U.S. stocks are outperforming. Sources: U.S. Federal Reserve, Vanguard.

Predicting the path of currency trends is nearly impossible. The important takeaway is this: After more than a decade of strong dollar performance and a shift in the foreign currency tides, a tailwind is improving foreign stock investment returns, and that wind may continue blowing.

Divorce Planning: Financial First Steps

Wealth Adviser Diana Linn, CFP®, CDFA®

The majority of couples who file for divorce do so between January and March. And while it may not be the cheeriest way to ring in the new year, it’s important to think about the financial aspects of the transition as soon as possible—we can help.

After you make the decision to divorce, some of your first calls should be to trusted professionals, including a lawyer and financial adviser. Here are a few things your wealth management team at Adviser can help you do right away:

Get organized. Gather all the documents your lawyer or certified divorce financial analyst (CDFA®) might need, including a list of all your assets and debts, Social Security statements, paystubs and all employee benefit information (W-2s, 1099s, and anticipated raises or bonuses expected for you or your spouse). You will also need a copy of all financial statements, the past three years of income tax returns, up-to-date credit card statements and insurance information.

Calculate your (and your spouse’s) expenses. We can help you create a comprehensive breakdown of debt and spending, both individual and joint, on a monthly and annual basis. You and your partner must complete this process separately, as your respective lawyers will need it as part of the financial affidavit process.

Plan for property. If you are a homeowner, have your properties appraised. Make sure you have the original date of purchase, the purchase price, a tally of home improvements, and the original mortgage amount as well as the remaining balance. All this information will be crucial in deciding if one partner will maintain ownership of properties or if you will sell them and divide the proceeds.

Consider dependent accounts. Gather all information on dependents’ savings accounts, 529 plans and UTMA accounts (Uniform Transfers to Minors Act). Research the guidelines for determining child support in your state—the noncustodial parent is usually ordered to pay child support, and each state has its own rules and tables.

Know your account numbers. Make sure you have access to account logins and passwords. Know when bills are due and keep tabs on everything from credit cards and cryptocurrency wallets to airline rewards points.

Divorce can be a stressful and lengthy process. Make sure you have the right people in your corner: Friends, family and professionals. If you have questions, call us. Our team has the experience to offer you the support you need through this life change.

Register for Our Quarterly Webinar Today!

Registration is open for Adviser’s first-quarter webinar, From Recession to RMDs: Our 2023 Outlook, to be held Tuesday, Jan. 31, at 2:00 p.m. (EST). Sign up here!

This quarter’s event introduces our new chief investment officer, Tim Clift, and includes timely advice and commentary from Manager of Financial Planning Andrew Busa and Wealth Adviser Liz Kesselman. The team will also answer your pre-submitted questions—please let us know what you’d like to hear about. We look forward to having you join us!

If you’re unable to attend the live event, you can sign up to get an email when the on-demand replay is available by clicking here.

Adviser in the Media

Portfolio Manager Adam Johnson appeared on Fox Business today with his analysis of earnings season to date, including Tesla’s report.

In our most recent Adviser Takeaways, Senior Research Analyst Liz Laprade looked at Elon Musk’s latest court appearance, while Wealth Adviser Diana Linn covered financial considerations during divorce.

Looking Ahead

Earnings season rolls on next week, including market-moving fourth-quarter results from tech titans Apple, Alphabet (Google) and Amazon. We’ll also get helpful reads on home prices, consumer confidence, manufacturing, job openings and quits, construction spending, vehicle sales, the service sector and the job market, including the January unemployment rate.

As always, please visit www.adviserinvestments.com for our timely and ongoing wealth management commentary. In the meantime, all of us at Adviser wish you a safe, sound and prosperous future.

About Adviser

Adviser is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.


Please note: This update was prepared on Thursday, January 26, 2023, prior to the market’s close.

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