Multi-Asset Solutions Quarterly Earnings Update

Key Takeaways:

• 35% of S&P 500 companies have reported with 70% beating sales estimates and 80% beating earnings estimates.
• Anticipated earnings growth of 5% for the quarter is conservative, and we expect estimate revisions to be positive exiting the quarter.
• The consumer remains resilient to higher prices with spending +21% Year-over-Year
• Consumption patterns are shifting away from pandemic supported durable goods purchases to services and experiences-based expenditures.
• Supply chain challenges are persisting, freight costs are elevated, and companies continue to push through additional price hikes.
• Homebuilders continue to see strong demand for housing despite higher interest rates.

1Q22 Earnings Review:

Two weeks into first-quarter earnings releases, 35% of the S&P 500 has reported results. The setup coming into earnings season was for 10% revenue growth and 5% Earnings Per Share (EPS) growth. Comparatively, fourth- quarter U.S. equities reported actual revenue growth of 16% and earnings growth of 31%. Annual growth rates are slowing as the V-shaped recovery from the pandemic matures against higher comparisons.

Results thus far have been encouraging. Company fundamentals are holding up well despite the demand and expense impacts from higher inflation. Out of the 178 companies that have reported, 70% have beaten sales estimates, and 80% have topped earnings expectations. The average revenue surprise is 2.6%, compared to the last four quarters’ average of 4%. Earnings surprises have been similar to the previous quarter at 7.6%, however, that is about half the rate of earnings upside experienced over the last year. The decline in surprises is typical as the economic cycle ages, and consensus estimates catch up to prevailing business momentum. We anticipate that earnings surprises will trend back to their pre-COVID average of 4%.

Given the low earnings growth bar, we expect earnings revisions to be slightly positive again this quarter. Since the end of March, the S&P 500’s calendar year 2022 estimates have increased by 1% to $230, and the 2023 EPS estimate of $252 is flat.

Stocks have been reacting well to the earnings beats. The average stock in the S&P has generated 111 basis points of alpha relative to the market following its earnings release. The sectors with positive earnings-related price action have been Technology and Consumer Staples, producing earnings alpha of 3.6% and 3.2%, respectively. Conversely, Communication Services have had the worst relative performance with a median relative stock return of -4%. Netflix (NFLX) shares were down -33% following their earnings report due to a miss and guide down on subscribers’ growth. From a valuation perspective, the S&P is trading at 16.7x the 2023 EPS estimate, in line with its 10-year historical average.

Source: Factset Estimates, Harbor Capital. Vertical axis is the quarterly earnings surprise of the sector. Horizontal axis is Earnings Alpha which is sector median excess return during the earnings window. Earnings window is one day prior to the event date through two days post earnings release. Bubble size is its market cap weighted sector representation.

Learnings from Earnings:

The Multi-Asset Solutions Team monitors a portfolio of industry bellwethers’ earnings reports to extract insights into the underlying economic variables we track in our Business Cycle Indicator. Our micro-to-macro process provides a boots-on-the-ground perspective of fundamental trends impacting economic momentum. This quarter, we are particularly interested in management’s comments related to the strength of the consumer, inflation’s impact on demand and cost structures, and developments in the housing sector, given the sharp advancement in both home prices and interest rates.

The consumer is resilient:

Monitoring the strength of the consumer and consumption patterns is a particular focus every quarter, given consumer spending accounts for 70% of the economy. It seems inevitable that the consumer will eventually be impacted by higher prices, and demand will weaken. However, first-quarter results from Financial and Consumer companies have sent a resounding message that the consumer remains unphased and resilient! JP Morgan kicked off earnings season with positive commentary around consumer spending. Combined credit and debit card payments increased +21% Year-over-Year. Jamie Dimon was confident in growth holding up over the next couple of quarters given the strength the bank is seeing in consumer spending, healthy consumer and corporate balance sheets, and $2T in consumer savings. JP Morgan’s sentiments were echoed by peers Wells Fargo and Citigroup, which discussed higher deposit balances and rising wages allowing consumers to weather the storm of higher prices across different consumption baskets. Synchrony, a private-label credit card company, stated that they believe two-thirds of consumers have either only spent a portion of their pandemic stimulus or have the entire amount of stimulus they received still in savings.

The elevated savings rates and strong balance sheets allow companies to pass on higher input costs. Procter & Gamble (P&G), a consumer products company with a needs-based health and hygiene product portfolio, discussed how they are not seeing consumers trade down from premium to private label brands. Typically, one of the first areas consumers attempt to stretch a dollar of purchasing power is by trading down to store brands. A resilient consumer resulted in the company reporting an organic growth rate of 10% aided by consistent price hikes. Their internal data shows that consumer price elasticity is 20-30% higher than what historical pricing data would indicate.

The other theme developing during the first quarter was a definite shift in spending patterns from durables to services. JP Morgan mentioned that card spending is picking up in travel and dining as COVID restrictions are lifted. The related industries are also noting the shift in demand. BJ Restaurants reported that same-store sales were +34% in the quarter and that they are seeing strong performance continue into April. The lodging sector also had positive comments on the inflection in demand. Both Park Hotels and Pebblebrook called out a substantial improvement in demand due to robust leisure travel and accelerating progress in business travel. Delta Airline’s commentary was similarly bullish, as they expect revenue to recover 93-97% of pre-pandemic levels by the end of the second quarter. Likewise, Delta is seeing a resilient consumer, noting that the consumer is prioritizing travel after two years of hibernation, and they are not seeing any weakness in their 60-90 day bookings window. Lastly, Google and Visa chimed in on the pickup in travel. Google reported better than anticipated results in Search aided by travel. Global payments processor, Visa, highlighted that they expect cross-border payment volumes to get back to 90% of 2019 levels by the end of September and are seeing improvements in volumes as travel restriction burdens are removed.

Peak Inflation?

We have not seen any signs of companies pushing price increases to offset higher input costs letting up in the first quarter. Companies across Consumer, Industrial, and Materials sectors are all discussing higher raw commodity input costs, supply chain challenges persisting, and elevated freight costs. Caterpillar (CAT), one of the largest manufacturers of heavy machinery, discussed on their call their expectations of raising prices again in 2022 as freight expenses are a pressure point and supply chains are not entirely healed, the business is having difficulties procuring semiconductors. From a demand perspective, CAT was negative on China due to weakness in the property sector.

P&G provided comments on the supply production impact of the COVID lockdowns in China. They noted that their Shanghai supply production is being negatively impacted due to the zero-COVID policy. Additionally, their exit rate on price increases was 6% compared to the 5% average for the quarter. The implication is that price increases are accelerating to offset commodity, freight, and foreign exchange challenges. From what we hear from businesses, it does not appear that higher consumer prices are slowing. This raises the potential for elevated consumer prices to be more persistent, increasing the risk of building inflation expectations.

Outside of supply chains, the residential REITs sector reported first-quarter results. Given the importance of rents in the inflation equation, we monitor rent growth for the group. On an aggregate basis, the group reported accelerating revenue growth against tougher comparisons. We will watch this line item in upcoming CPI reports as accelerating rent growth could signal more persistent inflation than has been building in the March “peak inflation” narrative.

Strong Housing Foundation Weathering Higher Rates:

The banking sector commentary on housing was cautionary. The fee income line was an area of weakness for banks this quarter, driven by softer mortgage banking results. JP Morgan reported that mortgage originations were down -37% in the quarter due to higher rates, with the 30-Year fixed-rate mortgage north of 5%.

However, the tone of the builders is more constructive. D.R. Horton reported strong calendar year first-quarter results, beating on the top and bottom line. D.R. Horton is one of the largest homebuilders in the U.S. and over indexes to an entry-level product. The builder continues to see strong demand for housing, despite the move in rates. The company highlighted that 100% of April closings were done with a rate lock, and most of the second quarter’s expected closings are locked. While they are seeing rate increases push some potential homeowners out of the market, the company said they still have more qualified buyers than homes they can produce. Additionally, they have not seen a material increase in cancelation rates at 16% in the quarter compared to a high-teens historical average. A supporting factor is that rents are escalating faster than prices for new homes, and homeowners want to lock in their housing costs. From a builder’s perspective, demand remains robust, and they continue to have the pricing power to offset higher construction costs. The average closing price in the quarter was up +21% Year-over-Year to $378K.

For more information, please access our website at www.harborcapital.com or contact us at 1-866-313-5549

Legal Notices & Disclosures

The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. The information provided in this presentation is for informational purposes only.

Performance data shown represents past performance and is no guarantee of future results.

Forecast and estimates are based on hypothetical assumptions and for informational purposes only. This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. The information presented does not represent the results that any particular investor may actually attain. Actual results will differ, and may differ substantially, from the hypothetical information provided.

Indices listed are unmanaged, and unless otherwise noted, do not reflect fees and expenses and are not available for direct investment.

Investing entails risks and there can be no assurance that any investment will achieve profits or avoid incurring losses.

Harbor Capital Advisors, Inc.

2188965