This week, CIO Tom Weary, CFA®️, shares earnings reports from several large banks as well as those from select RFA holdings across consumer staples, technology, and healthcare. He also gives a quick update on the economy and the four main trends underlying June’s inflation report.


Hi, I’m Tom Weary here at Reilly Financial Advisors with your Weekly Market Update.  This week earnings reporting season kicked off with a deluge of reports led by a number of banks.  But before reviewing those, let’s start with a quick update on the economy.

On Tuesday we had a very noisy report on inflation with the Consumer Price Index for June coming in at 5.4% higher than a year ago, surprising analysts to the upside.  The less volatile Core CPI came in at a 4.5% increase, still well above the Fed’s target for long-term average inflation of 2%.  But consumer prices don’t all move at the same pace or for the same reason. To get a sense of where inflation is heading, it helps to look at price movements item by item.  There are four main trends underlying the June inflation report.  First are the items where prices fell sharply at the start of the pandemic and that are now returning to their pre-pandemic levels, such as airfare and hotel rooms. Second are items where prices have temporarily risen above their pre-pandemic levels due to supply constraints and could come down, such as used car prices. Third are items where prices are likely settling at a permanently higher level, such as wages in the hospitality sector.  And fourth are items where price increases have slowed rather than accelerated as a result of the pandemic, at least for now, such as rents.  These trends exert competing forces on overall inflation as the economy adjusts to a new normal.  It’s very unlikely a year from now we’d be seeing this continued type of rate of change in inflation.

Banks led the way with strong earnings this week.  On Tuesday, J.P. Morgan Chase said second-quarter profit surged and customer spending is returning to pre-pandemic levels, evidence of a strong economic recovery that shows few signs of slowing.  The nation’s biggest bank posted a profit of $12 billion, or $3.78 per share, compared with $4.7 billion or $1.38 per share a year ago. That beat the expectations of analysts, who had predicted $3.20 per share.  Yet revenue fell 8% to $31 billion from $33 billion a year ago, the result of depressed lending margins and lower trading revenue.  While their investment bankers notched a record quarter on a flurry of merger activity, J.P. Morgan cut their outlook for net interest income due to the low-rate environment, and investors were not pleased to hear that.  First Republic Bank also chimed in with results on Tuesday that beat on both the top and bottom lines with revenue of $1.3 billion rising 34% from a year ago and earnings of $1.84 beating by 13 cents.  Bank of America said the economic rebound helped to more than double its profit, but low rates weighed on its revenue.   The nation’s second-largest bank by assets posted earnings Wednesday of $9.2 billion in the second quarter, up from $3.5 billion a year earlier. The bank earned $1.03 a share, beating the 77 cents forecast by analysts.  Bank of America’s bottom line was lifted by its decision to release $2.2 billion of reserves it had set aside during the depths of the coronavirus pandemic to protect against a wave of soured loans. Like peers including JPMorgan Chase, Bank of America has been releasing loan loss reserves as the U.S. economy rebounds.  But low rates and tepid loan demand have challenged banks. Bank of America in particular is sensitive to interest rates. Net interest income in the second quarter was down 6% from a year earlier.  US Bancorp, a holding in the Defensive Portfolio, reported on Thursday that it earned $1.28 per share for the second quarter, 14 cents above estimates, with revenue beating estimates as well.  Its results got a boost from an improving economy which helped boost credit and debit card revenue and allowed it to lower its credit loss provision.

We heard from two of our companies in the Consumer Staples sector this week.  PepsiCo issued second-quarter results on Tuesday that topped consensus estimates and raised its earnings forecast for the rest of 2021.  The company’s results and outlook indicate that sales are accelerating as consumers head back to restaurants, offices, and other locales where Pepsi sells its beverages and snacks.  The company reported overall sales in the quarter of $19.2 billion, 7% ahead of consensus forecasts for $18 billion. Net income came in at $2.4 billion, 13% ahead of forecasts. And earnings per share of $1.72 topped consensus estimates by 12%.  Pepsi largely reiterated its sales forecast for the rest of 2021, expecting 6% organic growth. But core EPS should reach $6.20 a share, up 12% from $5.52 in 2020, and ahead of the company’s prior forecast.  On a call with analysts, executives highlighted a few trends that are lifting sales. The big one is that “away from home” consumption is now accelerating as restaurants, convenience stores, and other businesses reopen.  And Conagra, a holding in the Defensive Portfolio, reported earnings of 54 cents per share, beating estimates by 2 cents, but revenue of $2.7 billion fell 17% from a year ago when consumers were stuffing their pantries during the pandemic.  Conagra lowered their guidance for fiscal year 2022 to $2.50 versus the consensus estimate of $2.64, which investors didn’t want to hear.  On the other hand, they did raise their dividend by 14% which confirms their confidence in their long-term outlook for growth.

On Thursday, Taiwan Semiconductor Manufacturing reported earnings of 93 cents, which beat by only 2 cents, on revenue of $13.3 billion which rose 28% from a year ago but missed estimates by $20 million.  The company expects the semiconductor shortage that has plagued carmakers this year to ease.  Strong demand for chips should nonetheless keep business humming.  The company says the automotive semiconductor shortage will be greatly reduced starting this quarter as it will increase output of microcontrollers for cars this year by nearly 60% from last year, or around a 30% rise from pre-pandemic levels.  TSMC, however, believes its capacity will remain tight as long-term increases in chip demand remain intact.  5G and other computing applications require more powerful and energy-efficient processors. TSMC expects sales this year to grow more than 20%.  While automotive chip shortages have been in the headlines, TSMC generates most of its revenue from smartphones or high-performance computing applications like central-processing units and graphic chips. Automotive only accounted for 4% of total revenue last quarter.  And of Friday Swedish telecom equipment maker Ericsson announced disappointing results that missed estimates on both the top and bottom lines.  The company said revenue in China dropped sharply in the most recent quarter and warned it would likely lose market share there as a consequence of Sweden’s decision to ban rival Huawei Technologies from the Scandinavian country’s 5G wireless networks.  Ericsson said Friday that second-quarter sales in China dropped by 60%, or nearly $300 million, compared with the same period last year. The company said the fall was due to China postponing deployment of 5G networks, a delay that some Ericsson executives believe disproportionately affected the Swedish company because of retaliation by Beijing.  Still, the company chalked up a big win outside China. It announced its largest-ever single deal, a five-year, $8.3 billion agreement to supply 5G equipment and services to Verizon Communications in the U.S., where Huawei is banned from major business.  Ericsson also raised their growth outlook for 2021 from 3% to 10%, but investors appear focused on the bad news out of China for the moment.

On Thursday we heard from United Healthcare, the nation’s largest health insurer and a Defensive Portfolio holding.  UnitedHealth posted a quarterly profit of $4.46 a share for the second quarter, down from $6.91 a share in the prior-year period. Revenue climbed to $71 billion, from $62 billion in 2020’s second quarter.  UnitedHealth’s adjusted profit of $4.70 a share in the quarter was better than the $4.43 a share that Wall Street analysts had been expecting.  The company’s medical-loss ratio—a measure of the proportion of premiums paid out for medical care—rose to about 83% because of the return toward normal levels of healthcare use.  A year ago, it was about 70%.  Overall medical costs rose to $47 billion, up by more than a third year over year.  UnitedHealth and other health insurers saw profits balloon in 2020 as people pulled back on doctor visits and trips to hospital emergency rooms.  UnitedHealth reiterated its projection that the pandemic would reduce its earnings by around $1.80 a share this year, with about 70% of the impact in the second half of the year.  The company flagged costs due to Covid-19 treatment and testing, as well as potentially higher medical needs due to conditions that worsened while people were steering clear of checkups, testing and other usual care.  Yet UnitedHealth raised its guidance for the full year, forecasting adjusted earnings of $18.30 to $18.80 a share in 2021.  That’s good news to investors.

So, what does it all mean?  The U.S. economy is in the midst of a surge unlike any witnessed in a long time as pent-up demand from the pandemic plunge intersects with re-openings and massive government stimulus.  While this is producing eye-popping numbers for inflation and GDP growth, I agree with the Fed that these are transitory.  Investors also appear more fixated with companies’ guidance for the future than what happened in the last three months.  Current growth is strong, but what about the second derivative – acceleration?  That number is likely negative.  Sorry, that was pretty nerdy of me, talking about second derivatives.  The economy will probably continue to grow, but at a lower rate.  Fed Chairman Jay Powell continued to sound dovish in his testimony to Congress this week, so monetary policy is set to remain super easy and the Senate has big plans for spending money on infrastructure.  The stimulus floodgates remain open.  We’ll stay on top of the latest developments on your behalf.  So, please, sit back, relax and join us again next week for the RFA Weekly Market Update.

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