It's "game on" this week, as the likes of PepsiCo (PEP), Domino's Pizza (DPZ) and other key multinationals report third-quarter earnings.
Based on early evidence such as a lackluster September jobs report (and downward revisions), a sluggish summer for the markets and a sales miss by Dunkin' Brands (DNKN) already in the mix, this coming earnings season could be outright weird -- by weird I mean earnings misses accompanied by announcements of more layoffs and global restructurings. Or a more cautious tone taken by management teams than what has been the case in the past 12 months, and pressured stock prices going down even further on the worrisome commentary.
I call what we are about to endure an "earnings recession," as many people with zero experience in financial services tend to refer to a year-over-year decline in earnings per share in a quarter. Recessions are brutal economic conditions and, although Corporate America is not lighting it up on the profit line, there are all sorts of companies winning sector by sector. On the contrary, I would call the next two months an "earnings reality check." The reality check arriving in the form of weak earnings that can't be supported by action from the Federal Reserve -- earnings have to be supported by top-line growth, which is tough when the global economy is slowing, as is the current situation.
Now is the time to stop trading the market, and prepare to trade the market in the weeks ahead. Here are eight things to watch for this period. No order of importance -- just things pulled together from discussions with execs in the last three months and my general view of the environment.
- Respect currency volatility. Don't be so quick to lock into a multinationals' "currency neutral" revenue, deem it rosy and then buy the stock. Companies have to manage currency swings just as they do marketing and product development plans. The companies with the best product and services are successfully raising prices overseas to compensate for currency swings. You want to own these companies.
- Currency volatility is likely to spur actions by U.S.-based companies beside adjusting prices overseas, much to the detriment of volumes. I suspect many multinationals will announce layoffs and plant closures in the U.S. to compensate for currency volatility. I would pay careful attention those restructuring their operations; once currency swings go back in favor of large global companies, the companies with lean operations will produce outsized earnings growth and command the premium operations. I like to see companies getting lean given a rationale view of the future.
- One may not get this number on earnings release day, but it will often appear on the 10Q: the percentage of revenue spent on product development. In a slowing economy, I favor those companies continuing to invest in developing products and services that stand to gain market share. Forget about a company managing its business to a quarter, over time; it's the innovators that will win. When was the last time you heard Apple (AAPL) slash product development to meet an earnings number during a sluggish period for the global economy? Never.
- Giant companies are reeling in marketing budgets reserved for traditional media. Those dollars are being reallocated toward mobile ads and structural investments to better target consumers online in real-time. View favorably those companies having the foresight to realize traditional TV ads are no longer the way to target consumers. Companies continuing to dump big money into TV are likely to get low or no return on their investment, trust me. It also shows a lack of vision by the executive team.
- Companies that try to gloss over weak third quarters and potentially weak fourth quarters while pointing to big things in 2016 should be frowned upon. The best executive teams are those driving results in this odd, global, macroeconomic climate.
- Along the same lines, outside of the financials, run from any company pinning bad quarters on uncertain interest rates. Give me a break.
- For consumer companies such as a PepsiCo or Chipotle (CMG), listen to how costs to develop products are trending. The cost of food items has been somewhat benign this year in large part because the economy has been growing rather weakly. Persistent borderline deflation would not be a good snapshot into the economy to start the fourth quarter.
- 8. Realize that, yes, even in a slowing global economy two of a sector's largest names could perform well due to new products and services. For example, I expect PepsiCo to have another strong quarter, despite a General Mills (GIS) rocking in snacks. Coca-Cola (KO) should have a solid quarter in many of its beverage categories, too. Foot Locker (FL) is likely doing quite well at the expense of Finish Line (FINL). Nike (NKE), Under Armour (UA) and V.F. Corp. (VFC) all continue to rock in the U.S due to superior innovations. Both Clorox (CLX) and Church & Dwight (CHD) are doing well, and their stock prices remain hot.