JPMorgan marked the start of third quarter earnings and cast a surprisingly positive light on the market. The financial sector had been under a shadow, with concerns lingering that rising rates on deposits would pressure margins and that credit losses would increase. Despite the worries, the issues didn’t materialize, at least for the largest banks. This positive start hints at a potential return to earnings growth for the S&P 500 after three quarters of decline, setting a promising tone for the rest of the year and into 2024.
In a world filled with significant uncertainties, and JPMorgan Chase CEO Jamie Dimon warning, “this may be the most dangerous time the world has seen in decades,” business fundamentals are not only better than feared; they’re also showing signs of improvement. As the earnings trickle in, they bring with them a sense of cautious optimism, offering a glimpse of stability amidst a turbulent global backdrop. Stay tuned as we keep you posted throughout this earnings season.
Financials
JPMorgan delivered a knock-out result, reporting 50% growth in earnings and beating investor expectations. This exceptional performance was bolstered by higher interest rates and the fortuitous acquisition of First Republic. Anticipation of higher credit losses and lower profitability proved premature, defying analyst forecasts. Jamie Dimon acknowledged the firm is “over earning” on net interest income and “below normal” credit expenses. As these factors catch up, they will serve as a drag on earnings for the next few years. Despite this looming headwind, JPMorgan remains a standout, in my opinion. I believe it has proven exceptional at managing its balance sheet amid rising interest rates. While many peers have experienced declines in net interest margins, JPMorgan increased its profitability sequentially. These remarkable results underscore the company’s resilience underpinned by its fortress balance sheet.
Charles Schwab investors breathed a sigh of relief after the company delivered an encouraging update. Bank sweep deposits returned to month-over-month growth and the trend extended into October. While Schwab isn’t out of the woods, this inflection signals that the worst may be behind them. The company has been grappling with deposit outflows since the Fed began raising rates. Investors moved cash from low yielding brokerage and checking accounts, that are highly profitable for Schwab, into higher yielding vehicles like CDs and money market funds. This cash migration had been abating until an unexpected surge in August caused panic among investors and a drop in share price. Fortunately, the August surge appears to have been a temporary anomaly, as cash outflows reached their lowest point in a year during September. Although emergency borrowing used to stabilize the balance sheet will impact earnings throughout 2024, the return to deposit growth allows Schwab to start repaying these high-rate loans and resume business as usual. Investors are still skittish, however the outlook for profit growth over the next few years is exceptionally strong.
Healthcare
Abbott Labs has recently come under scrutiny for several reasons. The medical device industry has faced significant market pressure due to concerns that widespread adoption of weight loss drugs might reduce the need for medical interventions in a multitude of diseases. Abbott is a major player in COVID diagnostics, and Pfizer’s lower-than-expected booster demand this Fall suggests testing demand will also falter. Revenue from COVID testing fell by $1.4 billion in the quarter, resulting in a slight decline in total company sales. However, when excluding this impact, the company’s sales grew almost 14%. Similar to what Johnson & Johnson reported, its underlying business is remarkably healthy, despite the headline drag from COVID. Further, Abbott’s analysis suggests that patients are not decreasing use of diabetes management devices along with weight-loss therapeutics; instead, there is an uptick in their usage. As the COVID drag abates and growth resumes in 2024, the medical device space seems ripe for a rebound.
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Consumer Discretionary
Netflix’s robust subscriber additions indicate that the streaming market still holds substantial growth potential. Despite a slowdown in membership growth in 2022 after adding 80 million subscribers during the pandemic, the company is set to gain nearly 25 million new subscribers this year. This growth is attributed to initiatives such as cracking down on password sharing and introducing a lower ad-based subscription tier. This positive news led to a surge in Netflix’s shares, further bolstered by an increase in free cash flow guidance.
In contrast, Tesla faced challenges with a 7% sequential decline in vehicle sales and a halving of its margin over the past year. To stimulate demand and secure market share, Tesla reduced vehicle prices. While this strategic move might be prudent amidst labor strikes affecting legacy automakers, investors are hoping for a brighter future. Tesla’s premium stock valuation has traditionally been based on its highly profitable business model. However, as margins align more closely with traditional automakers like Ford and GM, the stock is losing some of its appeal.
Bottom Line
Leading into the third quarter earnings season, the prevailing sentiment was one of caution, given the recent market trends. However, initial reports from various sectors indicate a more optimistic picture than what was originally anticipated. Key players like JPMorgan showcased impressive earnings growth, exceeding predictions and calming concerns about rising interest rates affecting profitability. This unexpected resilience is not isolated; it seems to be a trend as companies navigate challenges effectively. The positive outlook is reinforced by a broader economic stability. Companies, adapting to the ‘new normal,’ have managed to stabilize their operations, indicating a return to a semblance of pre-pandemic normalcy.
Looking forward, the prospect of brisk earnings growth in 2024 seems increasingly plausible. While uncertainties persist, the overall tone of this earnings season paints a hopeful picture for investors. As companies continue to navigate challenges successfully, the market might well be on the path to sustained growth.
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