Two Rotations to Consider During Earnings Season

When stock market analysts and observers talk about a rotation, they are usually talking about movements between asset classes or types of stocks. That might be referring to a time, for example, when money shifts from bonds to stocks as the economy strengthens, or from growth to value, as we saw early this year after growth stock P/Es had become inflated. As the Q3 earnings season get underway, investors should be aware of a couple of different kinds of rotations that will influence stock movements. Those who analyze the economy and assess the price of stocks are rotating away from a focus on supply and concentrating instead on demand, and consumer spending is shifting away from goods, to services and experiences.

Here we'll take a look at those rotations and where investors can look.

The Focus Rotation

For two years now, as the world struggled to recover from the unparalleled shutdown prompted by the pandemic, supply has been so important that the phrase “supply chain issues” has become an unlikely cliché. The ability of companies to overcome them and meet the demands of their customers has dominated the conversation about what makes a “good” stock. Now with central banks around the world raising rates to combat inflation, a war raging in Ukraine involving a nuclear power, chaos in UK markets bringing talk of a financial crisis, and economies beginning to slow, the ability to meet demand is less important than maintaining it.

It is important to understand that shift as companies begin reporting results, because stocks will move in response to completely different stimuli over the next month or so. Most notably, revenue will be more important this quarter than profit. When supply is restricted and input prices are soaring, controlling costs and maintaining margins are the most important things a company can do. Weak sales have been excused to some extent on the basis that they are a result of a temporary disruption, and everything has been about profitability. Now, though, stock in companies that can, or believe they can, maintain growth even as economic conditions worsen will be the winners as results and forecasts are published.

The Spending Rotation

Based on the latest Bank of America (BAC) Institute Consumer Checkpoint, released this morning, it seems likely that where those winners can be found is itself in a rotation. Post-covid spending was focused on housing -- both in terms of sales and improvements -- and basic goods like furniture and appliances. Now the data suggests that the housing market is slowing, which should lead to consumers tightening their belts, but we are not slowing down so much as shifting where our dollars go.

Spending on things like appliances and luxury items is down, but travel and leisure spending remains resilient, while the area of housing that is holding up best is home improvement. That would indicate that even if several major economies slip into recession, those industries, which are normally where consumers cut back first, could hold up quite well.

This earnings season, which begins tomorrow with PepsiCo (PEP) being the biggest name reporting, will, at times, seem confusing to investors. Some companies that miss expectations on earnings will see their stock move higher based on revenue or outlook. Others, that maybe make more profit than anticipated, will see the opposite. Guidance and revenue, not EPS or margins, will be the most important metrics.

To make sense of it all, investors should keep in mind that there are two simultaneous rotations taking place, one in where investors are keeping their focus, and one in consumer behavior. If you can understand that and filter results through it, some of what look like confusing reactions in stocks will make perfect sense, and post-earnings investment decisions can be made with clarity, rather than confusion.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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