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How Inflation Impacts Bank and Tech Earnings Risk

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Earnings season kicks off every year during the second week of October, with many of the country’s largest banks being the first to report. In the past, the importance of “bank week” was elevated, at least in part, because it came at the beginning of earnings season and might serve as an early indicator for themes. But this year is a little different.

Banks have been one of the best-performing sectors of 2021, so earnings will be scrutinized more closely than usual to see if these numbers justify current share prices. Toward the end of October and into early November is when technology behemoths like Apple, Microsoft, and Google report. These tech companies have gained so much market cap over the last few years that the six largest Nasdaq companies currently comprise 40% of the total Nasdaq-100 index. Earnings expectations remain elevated despite some concerns about an overall economic slowdown.

On Oct. 10, Goldman Sachs joined a growing group of analysts that have dropped their forecast for GDP growth in the coming quarters. Goldman cited persistent supply shortages, particularly in semiconductors, plus work-from-home trends that may reduce spending habits.

Other economists have also mirrored the slowdown sentiment. Can earnings remain robust in the face of an economic slowdown? Chief Strategist at Path Trading Partners Bob Iaccino believes the answer to this is yes. He explains that “when you are looking at earnings, you are not looking at a direct line to GDP” and “concerns of inflation are not historically bad for stocks.” Prior to bank week, 21 companies (or 4% of the S&P 500) had already reported, with 16 of those showing positive earnings surprises and 15 positive revenue surprises.

Scott Bauer, CEO of Prosper Trading Academy, notes that “when you break it down, it’s bank week and it’s tech week,” and these periods are clearly the most important parts of earnings season. Scott also points to using CME Micro E-mini Equity futures contracts as tools to help navigate the volatile waters of earnings season. “When a trader is hedging risk or adding risk, the micro contracts are useful because they are so liquid and so flexible… for the retail trader when faced with a binary event.”

Bob Iaccino echoes that opinion. “Often, important earnings releases are before or after the bell, and futures are the most liquid products during that time.

This earnings season is slightly different than past seasons due to how keenly we’re focused on inflation and its effect on company margins. The broad economic indicators have strongly suggested that, although producer prices have jumped considerably, increases have been slow to make it into the Consumer Price Index. Scott Bauer believes that “demand is going to be strong but we need to factor in the shortages and the higher costs, and that’s definitely going to affect bottom lines.” Scott also notes that “fifty S&P 500 companies have already given warnings regarding the effects of higher costs.”

Earnings season often represents increased volatility and increased risk. This season though is shaping up to be a unique one for a couple of reasons. Our overall economy is obviously in a transition period as we attempt to move away from the pandemic and the extraordinary stimulus measure taken by the government to support demand. This is also the first time in decades that most economists agree that inflation is here and that it’s real. Maybe inflation will be transitory, or maybe it won’t, but traders will be hyper-focused on any data that may offer answers to that question.

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