Whenever his audience was unresponsive to his jokes, stand-up comedian Rodney Dangerfield would invariably mutter: “Tough crowd.”

This earnings season, you could call Wall Street a tough crowd. The combination of rising interest rates, still-elevated inflation, a slowing economy, the banking crisis, and the debt ceiling fight in Washington is compelling a more critical view of corporate earnings.

That said, earnings as a whole have performed better than expected. Nearly 92% of companies have reported results for Q1 2023. Among these companies, about 78% have exceeded earnings forecasts, well above the long-term rate of about 73%, according to research firm FactSet.

Earnings growth for Q1 is expected to come in at -2.5% year-over-year, which is well above the expectation of a -7.0% growth rate at the start of the year.

However, Q1 will represent the second consecutive quarter of negative earnings growth for the S&P 500, and forecasts are calling for Q2 earnings growth to be negative as well, at roughly -6.5% year-over-year. Back-to-back quarterly earnings declines officially constitute an “earnings recession.”

A surly audience…

Wall Street has been stern with companies that miss expectations this earnings season. Companies that have reported negative earnings surprises for Q1 2023 have seen an average price decrease of 4.1% two days before the earnings release through two days after the earnings release (see chart).

The percentage decline of 4.1% is larger than the five-year average price decrease of 2.2% during this same window for companies reporting negative earnings surprises.

On the other hand, companies that have reported positive earnings surprises for Q1 2023 have seen an average price increase of 0.3% two days before the earnings release through two days after the earnings release. However, this percentage increase is below the five-year average price increase of 1.0% during this same time frame for companies reporting positive earnings surprises.

The line of thinking regarding whether a stock rises or not after an earnings beat has gotten more complicated. Fed tightening has made the quality of the beat increasingly important.

Rising interest rates also play an especially big role in regard to guidance. The value of any asset is its future cash flows discounted at the existing interest rate. When interest rates are rising, future earnings are worth less.

As 2023 unfolds and risks increase, investors are beginning to realize that companies will have to deliver outsized improvements to operating earnings to jump start growth rates.

Political headwinds…

Looming over the financial markets is the U.S. debt ceiling battle. Negotiations resumed on Tuesday, as President Joe Biden, House Speaker Kevin McCarthy (R-CA) and other congressional leaders got together to discuss raising the U.S. debt ceiling. As of this writing, the standoff remained unresolved.

The gathering in Washington follows the postponement of talks last Friday, when each side angrily accused the other of intransigence and bad faith.

However, in his remarks to reporters last Sunday, President Biden expressed a sanguine outlook: “I remain optimistic because I’m a congenital optimist. I really think there’s a desire on their part as well as ours to reach an agreement. I think we’ll be able to do it.”

WATCH THIS VIDEO: What The 2011 Debt Ceiling Crisis Teaches Investors Today

In past years, Congress has reached an agreement to raise the debt ceiling at the last minute, usually with major concessions from both sides. Since 1960, the U.S. debt ceiling has been raised 78 times. The federal government is expected to run out of money around June 1. Leading up to the so-called “X date,” you should expect a spike in market volatility.

If and when the debt ceiling drama is put to rest, investors can return to focusing on underlying fundamentals.

Retail sales miss expectations…

The U.S. Commerce Department on Tuesday released its advanced retail sales report for April and the data disappointed investors.

The report showed that sales were up 0.4% compared to March. The rise followed two months of declines, but the number was well below the consensus estimate of 0.8% and wasn’t adjusted for inflation. The headline increase equaled the 0.4% monthly rise in the consumer price index (CPI).

On an annual basis, sales climbed a paltry 1.6%, far below the 4.9% CPI pace. The upshot: Consumers are struggling to keep up with inflation.

Accordingly, the main U.S. stock market indices closed lower on Tuesday, as follows:

• DJIA: -1.01%
• S&P 500: -0.64%
• NASDAQ: -0.18%
• Russell 2000: -1.44%

Recessionary economic reports lately have worried Wall Street. The Federal Reserve’s scheduled meeting in June also has investors on edge. The betting is that the Fed will pause its rate tightening next month, but Wall Street has been overly optimistic before. If we don’t get a pause, Wall Street could prove a tough crowd, indeed.

PS: Are you spooked by the investment uncertainty I’ve just described? Turn to the time-proven advice of my colleague Jim Pearce. As chief investment strategist of Mayhem Trader, Jim has devised trading tactics that can buffer your hard-earned wealth but also generate gains. For details, click here.

John Persinos is the editorial director of Investing Daily.

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