The Transcript Q4 2022 Letter

What we learned from the Q4 2022 earnings calls

Summary: We summarize our key learnings from the Q4 2022 earnings calls as we prepare for the Q1 2023 earnings calls that start next week with bank earnings results.

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Macro

For most of the first quarter, the economy appeared to be performing surprisingly well. Consumer spending remained strong, and inflation remained stubbornly high. Just a few weeks ago the Fed appeared to be readying a more hawkish turn. However, the collapse of SVB has changed this calculus some. 

Although economic data has not shown any change yet, the financial turbulence has created a new source of risk. In response, the Fed has grown more hesitant to raise rates and is in a wait-and-see mode as it monitors the economy for potential ripple effects.

"...There’s so much uncertainty… It is too soon to determine the extent of these effects, and therefore too soon to tell how monetary policy should respond" - Fed Chair Jerome Powell [March 27th: Too Soon to Tell]

At the moment, the company commentary that we’re reading points to lower but still somewhat elevated inflation pressure. Goods inflation has clearly come down, but the Fed has begun to focus its attention on services inflation. The Fed is watching the strength of the labor market in particular for indications on inflation trends in the services segment. We have seen some signs that labor markets are not as tight as they were, but overall hiring appears to remain strong.

“...recent data suggest that consumer spending isn't slowing that much, that the labor market continues to run unsustainably hot, and that inflation is not coming down as fast as I had thought." - US Federal Reserve Governor Christopher Waller [March 6th: Waiting for More Data]

The juxtaposition of this strength with financial stress has led to a “fire and ice” dynamic within the economy that creates a challenge for the Fed. Last week, financial stress appeared to stabilize some, but the situation remains in flux and we should have more clarity on direction within the next few weeks.

“...you're in the throes of that battle between fire and ice. You have the knob being turned to try to fight against inflation. And then the question is, do you stop turning the knob? How hot is the CPI print going to be in a couple of hours? Can the Fed continue to turn the knob to try to get inflationary expectations down? Or given what's happened this week, the reaction function, to higher interest rates, do they need to either slow the knob down or turn the other one? That is this week, which is the fire and ice right before us. And I think it's something we should expect over the next 6 to 12 months." - Morgan Stanley (MS 0.00%↑) Co-President, Head of Institutional Securities Group Edward Pick [March 20th: Fire and Ice]

Against this backdrop, the S&P 500 finished the first quarter up almost 7.5% at 4109. In Q1 we learned that 2022 index earnings were $172.75, down 12.7% from 2021. This means that the S&P 500 sits at 23.8x earnings, or a 4.2% earnings yield. This compares to a 10-year treasury yield of 3.5% and a y/y inflation rate of 6.0%. It would require a significant decline in prices for the S&P 500 earnings yield to rise to more historic norms relative to current inflation and treasury yields.

International