Earnings season 2024: Market rewarding strong fundamentals signals a healthy economy 

We are about halfway through earnings season for US stocks, and the news so far has been overwhelmingly positive. This has been the driving force behind the strong start for stocks in 2024. 

We don’t pick individual stocks at Facet, but analyzing earnings remains crucial for tracking the economy and positioning Facet member portfolios appropriately. 

Here are our thoughts on some of the trends and insights we’re seeing so far.

Earnings season as macro analysis

When you own an individual stock, the company’s earnings report is a critical moment. Often, it is the most volatility a stock will experience for an entire quarter, which can make or break your success as an investor. 

Indeed, at most professional stock-picking firms, analysts will spend a great deal of time simply trying to figure out if a company’s profits will come in slightly higher (called a “beat”) or slightly lower (called a “miss”) than what others expect. This is a game known as “calling the quarter.”

This isn’t how we approach investing at Facet, and with good reason. It isn’t important to us which companies beat or miss their target. Instead, we closely analyze key company reports for insights into the broader market environment. 

We can use microdata from individual companies to confirm or question the macro data we get from government sources like the Federal Reserve or Bureau of Labor Statistics. We can also use management commentary from the firms reporting earnings to understand future plans to gauge business sentiment. 

With this in mind, here are a few of the insights we’ve gleaned from earnings so far.

Volume sales increasing, prices holding

In 2022 and 2023, many consumer firms were happy to increase profits by raising product prices, even if that meant selling the same number of (or fewer) units. After all, producing more products is expensive, and getting your consumers to pay more for the same product is extremely profitable.

This method worked when inflation was high, but now, with inflation subsiding, companies have to refocus on increasing unit sales. The best way to see this is by looking at companies that sell a high volume of relatively low-priced consumer goods, such as Procter and Gamble or PepsiCo. 

Both firms gave similar guidance to investors. This quarter, Procter and Gamble had the highest North American unit volume growth in five quarters. They said their ability to “reaccelerate volume” would be key to success in 2024. 

PepsiCo warned that revenue in the coming quarters might be lower than previously projected as consumers have balked at higher prices. The company said that getting to a “better balance” between volume and pricing was going to be necessary.

Macro-wise, increasing volume sales makes for a much healthier economy than simply raising prices. Obviously, it suggests a lower inflation rate, which is certainly good. However, companies producing more products for sale generally need to hire more and spend more on supplies and advertising, among other things. In effect, it results in a broader range of healthy economic activity and often has a beneficial ripple effect on other areas of the economy.

Freight is rebounding

The volume sales rebound is also impacting the freight business – companies that transport, import, and export goods. The combination of weaker consumer spending on physical goods and a downturn in manufacturing resulted in what was being called the “freight recession.” 

Indeed, rail companies like CSX and Union Pacific saw four consecutive quarters of declines in a metric called “carloads,” which is essentially a measure of how much volume each firm is shipping. That streak was broken this quarter, where both companies saw a combined 2.5% increase in volume over this same quarter last year.

Source: CSX and Union Pacific earnings reports

The freight business is known as a “hyper cyclical” industry, which means it often goes through deep downturns even while the rest of the economy is doing fine. So, one should be careful not to overinterpret the fluctuations in freight volumes. 

However, the rebound in shipping volumes is a good example of the ripple effect we mentioned earlier. Consumer companies producing, shipping, and ultimately selling more are good for various companies. The high inflation environment appears to be giving way to a more sustainable, high-volume economy, and the transportation industry is benefiting.

Tech earnings reflect strong fundamentals

Much has been made of the surge in tech stocks in recent quarters, especially the so-called “Magnificent Seven.” 

Some experts are reasonably questioning whether these companies have become overvalued due to their massive upswings. However, it is worth noting that, generally speaking, the companies delivering the best stock price performance during this earnings season are also the ones producing the best business results.

One factor to consider is online advertising revenue, the primary business of two Magnificent Seven members: Alphabet and Meta. 

Here is the advertising revenue growth for both companies in recent quarters, compared to that of Snap.

Source: Alphabet, Meta and Snap earnings reports

Here, we see that ad revenue was growing robustly for all three companies in 2021, a time when all three stocks were soaring. Then, in 2022, revenue growth fell substantially, turning negative for Alphabet and Meta by the end of the year. 

During that period, these stocks all fell meaningfully. From last year to now, ad revenue has grown again at Meta and Alphabet, but Snap remains sluggish. 

Investors often get hung up on what moves the broad market on any given day. For most of 2022 and 2023, speculation about the Federal Reserve’s next rate move has often been a big market driver. But if we look at the ad revenue chart above, it more accurately tells the story of what happened to tech stocks over the last three years. Their core business was extremely strong in 2021, turned weaker in 2022, and rebounded in 2023. The stock prices reflected these basic fundamentals.

This is also reflected in how each stock has performed relative to their peers. Meta has seen the strongest revenue growth this past quarter, up more than 32% so far in 2024 (through February 9). Alphabet has realized a more modest rebound, only up 7%. Snap has barely recovered at all, down 34%.

We see similar patterns in other tech business lines, such as cloud computing or semiconductor sales. The companies’ earnings patterns of the last three years broadly mirror the performance of their stocks. This is generally true both at a high level for the tech sector and at an individual stock level. 

Companies like Tesla, Intel, and Apple that have produced disappointing results are underperforming, while those with strong growth forecasts like AMD, Palantir, and Salesforce are outperforming.

Again, Facet doesn’t pick individual stocks, so it is less important to us which companies outperform. However, it is a sign of good market health when the market rewards companies with solid business results instead of rising in a more speculative fashion.

Commercial real estate remains challenged

New York Community Bank grabbed headlines when it announced a large writedown of its commercial real estate (CRE) loan book at the end of January. The move sent shares of the bank, which is focused on apartment building loans in New York City, tumbling more than 50%. 

Facet has been concerned about the CRE business for some time. So, it is worth wondering if this bank’s credit troubles are a kind of early warning sign of broader problems in the banking industry.

On the one hand, there has been little evidence of acute credit stress related to CRE in banks generally. Indeed, larger US banks have recently been increasing their loan loss reserves, which is the money banks set aside for the amount of loans expected to go bad. However, the increase in reserves so far has mostly been tied to the general rise in the volume of loans. 

As banks simply make more loans, they have to set aside more for losses. Other banks have not been pointing to the kind of material losses that New York Community Bank has suffered.

That being said, the real estate business continues to look challenged. Boston Properties, the largest publicly traded office building developer, reported occupancy at their properties at 89% this quarter. 

The good news is that occupancy for the company has been steady since 2021, while overall office vacancies are rising. The bad news is that occupancy for the company was 93% at the end of 2019. 

In its earnings call, the company argued that its properties are “premier” buildings, which has allowed it to maintain occupancy despite weakness in the broader industry. 

If that is the case, it implies that Boston Properties might be taking tenants from smaller office owners, which is good news for Boston Properties but bad news for real estate overall.

Our belief is that real estate is going to remain a tough sector for a while to come. There are too many headwinds, including weak occupancy rent growth and high interest rates. In some cases, this will probably result in some bad loans at banks, but right now, the risk appears to be manageable. 

Earnings show an economy gaining momentum

At Facet, we’re long-term investors. We don’t analyze earnings season in an attempt to time the market or pick winning sectors. However, our proactive approach to investing does involve trying to balance our portfolios for various possible economic and market outcomes. Listening to what companies are saying about what they are seeing and their future plans can be a very valuable input in that process.

What we are seeing so far this earnings season is overwhelmingly positive. The era of high inflation and significant price increases appears to be over. Companies are going back to competing on volume sales, and that is having a number of beneficial knock-on effects. 

Meanwhile, the market is rewarding the companies that are producing strong fundamental results, which tells us that if companies keep growing profits, the market should keep going up.