This week, Cut the Crap Investing founder Dale Roberts reviews the latest financial headlines and explains what they mean for Canadian investors.
Does this earnings season matter much?
The market has been behaving erratically, and this earnings season may be especially noisy and of limited long-term value. For investors, the single most important factor remains inflation and how central banks respond to it. Yet markets continue to react strongly to each earnings report and every central-bank comment.
Earnings reports are inherently backward-looking. They reveal how companies performed in the past quarter, but they offer only limited insight into the economic environment that will shape profits over the next year or three. What truly matters is the future path of inflation and demand—how hard the Federal Reserve and other central banks must act to bring price growth under control.
Central bankers face a difficult balancing act: applying enough monetary tightening to reduce inflation without triggering an overly severe economic contraction. Since mid-June, U.S. markets have recovered some losses, bolstered by solid earnings from some companies and growing speculation that rate hikes may slow or pause.
This column offers a primer on the Fed’s tone—how “dovish” or “hawkish” central bankers sound—and why those words move markets. Short comments from officials can rattle investors and alter expectations. For example, San Francisco Fed president Mary Daly emphasized that the Fed has taken meaningful action but that many people are still struggling with higher prices.
—San Francisco’s Mary Daly
The physics of a soft landing
Central banks are attempting a soft landing for the economy. Imagine inflation as a ball attached to a long elastic band falling from the sky: the goal is to increase the rate of descent just enough so the ball stops before it hits the ground and then settles into a stable range. Policymakers aim to return inflation to roughly 2%–3% without causing a sharp recession.
That task is extremely difficult. Economic growth is already slowing and many indicators suggest inflation may begin to recede, but calibrating rate increases to achieve a gentle slowdown is rare and challenging.
Earnings highlights to watch
Earnings tell us which sectors are holding up in the current inflationary, slowing-growth environment and offer management commentary about demand, pricing power, costs and supply-chain pressures. Below are several notable results from recent quarterly reports.
Energy continues to act as a de facto inflation hedge. Canadian oil and gas producers reported substantial cash flow and dividend actions:
Canadian Natural Resources (CNQ/TSX) reported quarterly earnings that nearly tripled from a year earlier and free cash flow that nearly doubled, enabling a 28% increase to the quarterly dividend in March and a special dividend announced with the results.
Tourmaline (TOU/TSX) reported record free cash flow and declared a special dividend.
Suncor (SU/TSX) delivered record adjusted funds from operations, more than doubling versus the prior year, and significantly higher operating and net earnings in the quarter.
Energy stocks are cyclical and will be sensitive to any sharp economic slowdown or recession. Investors in these names should expect and be prepared for wide price swings.
On the defensive side, healthcare and consumer staples remain attractive for investors seeking stability. I’ve written in the past about a recession-ready portfolio that includes defensive names such as CVS Health, Johnson & Johnson, Abbott Labs and Medtronic, along with low-cost retailers like Walmart.
CVS Health (CVS/NYSE) recently reached a multi-month high after raising its 2022 earnings guidance following a strong quarter. The company beat revenue expectations and the stock has seen solid performance over the past year, making it a standout for those already holding shares.
Consumer-staple results provide insight into the consumer’s health.
Colgate-Palmolive (CL/NYSE) beat expectations and reported revenue growth of $4.48 billion (+5.2% year over year), raising its organic sales guidance for the full year to 5%–7%. CEO Noel Wallace noted continued vitality among consumers globally but observed a slowdown in developed markets, especially Europe. The company also highlighted substantial inflationary pressure, forecasting roughly $1.3 billion in raw-material and packaging cost increases and higher logistics costs, with foreign-exchange headwinds increasing.
The takeaway: developed-market consumers are showing signs of strain, while global conglomerates face rising input costs, supply-chain disruption and currency translation losses when the U.S. dollar is strong.
Has the U.S. entered a recession? What about Canada?
Technically, the U.S. experienced two successive quarters of GDP decline and therefore qualifies as being in a technical recession. Canada, meanwhile, has posted modest growth and had avoided contraction in some recent months, though the two economies remain highly synchronized. Historically, Canadian recessions have occurred at the same time as U.S. recessions, reflecting the close economic linkage between the countries.
Canada’s exposure to natural resources and its real estate sector means a Canadian downturn can be shaped by different forces. The Bank of Canada has signaled a willingness to combat inflation even if it deflates housing activity. Several analysts now expect home sales and prices to decline materially from their peak, and mortgage borrowing costs have risen sharply this year: variable mortgage rates have increased substantially and five-year fixed rates are meaningfully higher, weighing on affordability and demand.
If Canada does fall into a recession, it may be driven largely by cooling in the housing market as borrowing costs and lower demand bring prices down from record highs.
Global growth and inflation trends
Global business-activity surveys and inflation indicators show slowing growth across many developed economies, with the U.S. leading the weakness. Emerging markets remain relatively stronger. Some inflation pressures are easing, but wage growth and elevated energy costs could keep inflation more persistent than policymakers would like, complicating the path back to stable price growth.
July market returns and sector trends
July marked a meaningful rebound for U.S. equities, the best month since 2020 for many indexes, while bond losses earlier in the year were also historic. Sector leadership in July included energy and defensive sectors—utilities, consumer staples and healthcare—which underscores a rotation toward safety amid economic uncertainty. Large growth names remain volatile and some of the megacap stocks have experienced deep drawdowns even as indexes recover.
“Stocks off lows but still finished lower, pulled down by Energy (courtesy of drop in oil) and mix of defensives/cyclicals; Cons Staples’ relative outperformance today and YTD has underscored general flight to safety …”
Investors have debated whether recent market strength reflects a durable recovery or merely a bear-market rally. Some interpreted Fed Chair Jerome Powell’s comments as suggesting a pause in hikes, while others warn that the Fed is still committed to further tightening if necessary.
“Investors have lately become strangely optimistic that the Federal Reserve won’t have to tighten monetary policy much further… This wishful thinking is both unfounded and counterproductive.”
Sentiment swings can be dramatic—sometimes investors cheer prospects for lower rates, other times they rally on extreme risk-off headlines. Yet the underlying reality remains: inflation and the Fed’s response will steer the economy and corporate earnings going forward.
For individual investors, the advice is straightforward. If you are in the accumulation phase, continue to invest according to your plan and dollar-cost-average into the market. If you are retired or approaching retirement, assess your portfolio’s vulnerability to market volatility and protect against risks that could jeopardize your income and capital.
Dale Roberts advocates low-fee investing and writes at cutthecrapinvesting.com. He posts regular market commentary on Twitter under the handle @67Dodge.