The Transcript Q2 2022 Letter

What we learned from the Q2 2022 earnings calls

Note to our esteemed readers:

It’s been 4 quarters of writing our quarterly letter to our subscribers to review the key trends that we saw in the latest earnings season. This week, we are publishing our letter for the Q2 2022 earnings season. The Macro section is available for our free subscribers and the rest is available only to our premium subscribers. Enjoy it!

- Scott and Erick

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The companies we covered in this letter include: AAL 0.00%↑ ABT 0.00%↑ AKAM 0.00%↑ BP 0.00%↑ CRM 0.00%↑ DG 0.00%↑ GOOGL 0.00%↑ GS 0.00%↑ IAA 0.00%↑ INTU 0.00%↑ MC 0.00%↑ MU 0.00%↑ PSI 0.00%↑ SIVB 0.00%↑ SPGI 0.00%↑ STWD 0.00%↑ UAA 0.00%↑ URBN 0.00%↑ W 0.00%↑ WMT 0.00%↑

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Macro

We’re now two-thirds of the way through 2022. So far this year has been dominated by the Fed’s response to high levels of inflation and the possibility of a recession. For much of the summer, it looked like optimism would prevail and prevent a recession. However, since Jerome Powell’s remarks at Jackson Hole capital markets have once again weakened. Powell’s remarks reaffirmed the Fed’s hawkish stance toward inflation. It will be hard to avoid a recession if the Fed is actively trying to slow the economy. This doesn’t seem to bother the Fed either, which further increases the odds of a recession.

“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain” - Fed Chair Jerome Powell (29th Aug: Until the Job is Done)

Despite concerns of a recession, we’ve cataloged more positive macroeconomic commentary than negative commentary in recent weeks. Still, we’ve recently been noticing that there is a negative divergence between macroeconomic and microeconomic commentary. Many companies are seeing signs that could indicate that we are in the early stages of deceleration. These signs include bloated retail inventories, lower-income consumers trading down, falling used car prices, the pace of hiring slowing down, and weak consumer electronics sales, to name but a few.

"So as used car prices are moderating there, we're sort of -- we're buying and as the prices are falling. So we're having to sell at a -- the spread that we've established isn't as wide as we would have expected." - IAA CEO John Kett (22nd Aug: Under Pressure)

"We are observing some trade-down behavior within various classes at home..It's not that specific types of goods are getting traded down, other types of goods aren't. It's more a little bit across the board" - Wayfair CEO Niraj Shah (8th Aug: Optimism Prevails)

“At the end of Q2, Walmart U.S. inventory growth was 26% versus last year, reflecting over 750 basis points of improvement from Q1 levels -- We have cleared most summer seasonal inventory, but we are still focused on reducing exposure to other areas such as electronics, home, and sporting goods." - Walmart CFO John Rainey (22nd Aug: Under Pressure)

“Given the uncertain global economic outlook and the hiring progress achieved to date…we intend to slow the pace of hiring. We expect our actions on hiring to become more apparent in 2023" - Alphabet CFO Ruth Porat (1st Aug: What’s Priced In?)

“we believe that growth profit margins could decline by more than 400 basis points for the third quarter. The decline in third-quarter gross profit margins could largely be driven by higher markdown rates versus last year's exceptionally low markdown rates at all brands as well as elevated inventory levels this year." - Urban Outfitters CFO Melanie Marein-Efron (29th Aug: Until the Job is Done)

Similarly, earnings have not been strong. According to S&P, second-quarter earnings were down 11.9% from 2021. This was less bad than feared, but still quite weak. With monetary and fiscal stimulus reversing, the outlook for corporate earnings does not appear particularly strong. In the most simplified form, equity prices are a function of earnings and interest rates. Both inputs appear under pressure at the moment.

“And up to this point, corporate earnings have hung in reasonably well..I think the big thing to watch in the next 12 months is corporate earnings. If you're a student of history, any time we've been in this kind of environment a decline in corporate earnings lags and comes next. And that should put-- that may put, not should-- that may put a little bit more pressure on stock markets." - Goldman Sachs CEO David Solomon (25th July: Can't See No Recession Yet)

International