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We made several changes to our position monitors in Restaurants and Consumer Staples ahead of the Q3 earnings reports. The markets have endured one-quarter of Quad 4, and our Macro Team is calling for three more. The stocks of many companies have sold off indiscriminately in Quad 4. We see opportunities for several companies with an improving earnings outlook, at the same time, we still see further downside for other companies on the short side of our position monitor. Our changes reflect where we see the upside/downside in Quad 4. We still think it is too early to invest for what is on the other side of Quad 4.
In Restaurants, we suggest that a number of companies will see significant margin pressure from slowing sales trends and raging inflation. The Hedgeye Restaurants watch list is down 29% YTD, but earnings revisions have not yet begun to come down nearly enough. Some stocks are beginning to reflect the disappointing earnings, but others are bucking the trend. The next six months will be very challenging for the industry as sales continue to slow and inflation remains sticky. On the call, we will be broadening out the list of potential names we want to buy in the next down draft.
In Consumer Staples, we anticipate a Q3 earnings season that will be more selective over winners and losers. The Consumer Staples sector is historically one of the best performing sectors in Quad 4. However, the unique challenges in the current Quad 4 environment suggest to us that a basket approach to owning the entire sector is not the way to go. Elevated agriculture commodity prices, strained consumer budgets, a generational high in food inflation, fading transfer payments, and supply chain bottlenecks have created a Quad 4 environment that likely rhymes but does not repeat recent Quad 4s. We expect the list of Consumer Staples stocks outperforming in Quad 4 will narrow this Q3 earnings season as investors have less patience for companies having new issues. With heightened anxiety over the Fed's actions and the economy's resiliency, there is little tolerance for slowing outlooks. At the same time, several Consumer Staples companies will see margins inflecting in Q3 with improving top-line projections. With so many challenges in the broad market, we see a narrower group of Consumer Staples companies will be perceived as the "best house on the block."
OUR UPDATED POSITION MONITOR:
