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Earnings are showing a ‘fair amount of strength’ despite ‘deceleration in growth’, strategist says

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Credit Suisse Co-Head of Quantitative Research & Senior Equity Strategist Patrick Palfrey joins Yahoo Finance Live to discuss earnings results so far, the bear market, and the outlook for macroeconomic uncertainty.

Video Transcript

- Well, for more on a busy day in the markets, let's bring in Patrick Palfrey, Credit Suisse co-head of quantitative research, senior equity strategist. Great to have you on this morning. There's a lot to unpack in this market, but just broadly speaking, wondering how you're viewing the earnings that we've gotten so far.

Again, we're very early into this earnings season. We've got the banks, and we've got some of these large companies like Tesla reporting and hitting the tape as well. Any noticeable trends that you're seeing?

PATRICK PALFREY: Well, I think when we take a look at earnings across the board, for the most part, we're seeing a fair amount of strength. And I think investors, coming into this earnings season, were concerned about the deceleration in growth. And we're seeing it, but it's not nearly as bad as feared.

Right now, we're gonna expect EPS to finish this quarter up around 9%. And it's coming from sales growth. That's 13% to 14%.

That's a big number. Part of that margin contraction is coming from financials. So it's not broad-based. There are certain groups which we're seeing that margin pressure.

But, generally speaking, we're seeing a fair amount of strength across the board. I think banks is one area where we're seeing a little bit more increase in reserves. And I think investors are looking ahead to see if there is recessionary impulses in that process. But, for the most part, we're feeling comfortable with this coming earnings season.

- So, Patrick, the big question for retail investors is, have we reached the bottom? It's been an ugly 2022 so far. When you take a look at the bank earnings, very interesting because you had some mixed results from Citi and Wells Fargo last Friday, but then it ended up ripping up higher.

So, you know, you're kind of seeing the same thing with Tesla shares today. You saw a first quarter-over-quarter decline in a while, and yet shares are up. So is there anything that's telling you about where we are in valuations right now and whether or not-- again, don't want to say it too early-- but we've reached the bottom?

PATRICK PALFREY: So I think we very well could have. If you look back to June 16 is where we put in the most recent bottom. Market is up 6% to 7% since then. And, really, what happened at the start of this year is we came into 2022 with very elevated valuations across large swaths of the market.

And what we experienced as volatility rose, as interest rates picked up, is a compression in the cost of capital. All that's saying is the future discounted cash flows were worth less. And the valuations compressed because of that.

Where we are now in the process is a really cleared house in the valuation story. And we think we can see the market continue to grind higher as we see the macroeconomic uncertainty begin to fade and as investors become more comfortable with the economic backdrop, nonrecessionary. I think that's important.

We are decelerating. I think that's clear. But we don't necessarily view it as a recessionary concern at the moment.

- And I think another theme that people are thinking about a lot is just the baseline and expectations that happen after the last earnings quarter. It seems like maybe this is going to be the first quarter where we're seeing company performance measured up against what is a more downgraded view of what future cash flow might be.

How important of a story do you think that is? Does that make guidance that's gonna be coming out from these companies this earnings season as relevant of a story as it was last season?

PATRICK PALFREY: 100%. I mean, I think the nice thing about earnings is it gives us that snapshot into what companies are seeing. Typically, what we're trying to do is trying to understand what's happening by looking at unemployment conditions or looking at PMI indicators to try and gauge that. But the companies are giving us, really, an on-the-ground look. And guidance is a key component of what they see for the back half of the year.

When we look at what's coming out, growth for the third and fourth quarters right now is expected to be anywhere between 13% to 10% in the fourth quarter. So we're seeing double-digit trends. And we're not seeing a severe negative revision around that.

I think that the issue was higher input costs are going to pressure margins, and that's gonna cause estimates to fall. In reality, higher input costs typically get passed through. And then you see leverage on that. So the concerns that investors had around the back half of the year in terms of earnings declining or falling materially, we're just not seeing that at the moment. And guidance from companies is really reinforcing that backdrop.

- Let's talk about sectors. I understand you had a note recently that kind of highlights some of the overweight, underweight sectors you want to be in or not be in right now. A discretionary one that's very much in view-- and this is so interesting because this is part of the inflationary story, right? A consumer that is willing to spend and go into the balance sheet to do that is good for these companies. But, at the same time, the inflationary story might be changing very rapidly with the Fed movement and also, perhaps, with the demand destruction happening already. So what's the thesis on specifically discretionary?

PATRICK PALFREY: So I think what we take a look at discretionary, the pushback that we commonly get is higher inflation is eroding the wage gains that employers are seeing. So with wage gains at 5% and then CPI up 9%, what you're seeing is negative real wage growth. And that's certainly true.

We do expect inflation to begin to cool over the back half of the year. It's not gonna decline nearly as fast as we would have thought at the beginning of the year because of some of the pressures around energy prices and food prices. But, nevertheless, we expect that to begin to decline.

So real wages will begin to improve. And, at the same time, the consumer wallet, whether it's measured in wealth from housing or whether it's measured in savings that they got over the course of the pandemic, still remains quite strong. So they had the ability to make up for the softness that they're seeing in real wage gains.

And, as a result, people want to get out there. They want to spend. They're consuming services to the extent that they can. And I think the concern that many investors have that spending is gonna collapse because of inflation just isn't quite yet materialized when we look at the data.

- All right. Patrick Palfrey, Credit Suisse co-head of quantitative research and senior equity strategist. Thanks so much for joining us this morning. Really appreciate it.