Global Weekly Commentary: Earnings unlikely to spoil stock rally
We don’t see Q4 earnings challenging upbeat risk appetite even as we see 2024 earnings growth below the consensus. We’re overweight U.S. stocks overall.
U.S. stocks hit an all-time high last week as mostly solid tech earnings offset some disappointments. U.S. 10-year yields jumped on robust January jobs data.
We follow this week’s global PMIs to gauge how firms are adapting to still-high rates. China credit growth is in focus to gauge the impact of policy stimulus.
U.S. Q4 corporate earnings season is in full swing. We don’t see it spoiling upbeat risk appetite for now. The S&P 500 hit an all-time high last week as most top tech firms beat high earnings expectations. Yet we think earnings will recover less than markets expect this year after stagnating in 2023. Tech gains and cost cutting have buoyed margins, but we see pressures mounting over time. We’re overall overweight U.S. stocks as we think rosy market sentiment can persist for now.
Big tech buoys margins
U.S. net profit margins for the past 12 months, 2015-2024
Source: BlackRock Investment Institute, with data from Bloomberg, January 2024. Notes: The chart shows net corporate profit margins for the seven largest companies listed on the S&P 500 by market capitalization (mega cap seven), the S&P 500 excluding the mega cap seven, and the overall S&P 500 for the past 12 months.
We’re in a new regime of greater macro and market volatility, and that’s reflected in corporate profit margins. S&P 500 net profit margins expanded to all-time highs during the pandemic as firms passed on higher costs to consumers. The reversal of pandemic spending patterns and solid wage growth have pushed margins down from a peak of roughly 13% (green line in the chart). Still, margins have held up better than we expected against these pressures and higher interest rates. We think a handful of mega cap tech firms – those with ultra-large market capitalizations – have buoyed margins. Stripping out mega cap tech, S&P 500 profit margins have normalized closer to pre-Covid levels (yellow line). Cost-cutting measures such as layoffs have helped companies preserve profit margins for now. We think margins have room to fall further once cost cutting ends and inflation resurges.
Mega cap tech stocks have rallied since last year over excitement about artificial intelligence (AI). Digital disruption and AI is one mega force, or structural shift, we seeing playing out over years and being a key earnings driver. Our work finds a positive correlation between a rise in AI patents and earnings growth in the one-to-two years after the patent registration. Analysts expect mega cap tech earnings to grow 21% this year – a third of S&P 500 earnings growth, LSEG data show. That’s a high bar, in our view. So far, most mega caps tech names have beat lofty Q4 expectations.
Meanwhile, analysts expect broader earnings to grow about 11% this year, in line with expectations for S&P 500 margins to rebound toward 13% in the next 12 months, LSEG data show. That earnings growth would be an improvement from stagnation, with earnings on track to have grown just 1% in 2023. We expect earnings to land just below consensus this year. And while we think margins could tick up, analyst estimates look too optimistic. We see cost pressures on margins mounting as the year progresses. Yet tech delivering on earnings and further cost-cutting measures could alleviate pressures for now.
Ultimately, we think market sentiment on stocks is anchored on the outlook for policy rates and inflation. Stocks rebounded quickly from mixed tech earnings earlier last week and after Fed Chair Jerome Powell ruled out a rate cut as soon as March. The Fed is watching for inflation to fall sustainability to 2%. We’ve said before that we think goods inflation will push inflation near 2% this year. What matters is we think the Fed will start to cut rates as that scenario plays out. Yet we believe the rally will be upset by resurgent inflation coming into view later this year and margins facing pressure. Still-high wage growth is one key factor that will put inflation on a rollercoaster toward 3% in 2025, in our view. That will likely renew cost pressures on companies. We watch for wages growing faster than the prices received by good producers to gauge margin pressures.
Our bottom line
We’re overweight overall U.S. equities, including the AI theme, on a tactical horizon of six to 12 months. That’s because we think the rosy market sentiment has room to run for now. Earnings and margins won’t spoil the mood yet, in our view. We’re neutral U.S. stocks on a strategic horizon as we expect high-for-longer interest rates to weigh on valuations.
U.S. stocks pushed to new record highs, recovering from some mixed earnings results and the Fed pushing back against market pricing of a rate cut as soon as March. Some mega cap tech companies only met lofty earnings expectations, but enough handily beat the expectations to lift the broader market. U.S. 10-year yields jumped after the January payrolls report showed robust job gains and a pop in wage growth. We think ongoing wage pressures and other structural forces will put inflation on a rollercoaster. That’s why the Fed won’t be able to cut rates as much as the market still expects, in our view.
Global PMI data takes center stage this week as we take stock of how corporate margins are holding up against high interest rates. China credit data is also in focus after authorities launched policy stimulus and vowed to support growth at the end of January. We don’t think the structural challenges China is facing this year – and in some cases, further out – have changed: a high savings rate, low domestic investment, a shrinking labor force and waning foreign investment.
U.S. trade data
China CPI and PPI
China total social financing
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of Feb. 1, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12 months, and the dots represent current 12-month returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
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