Global Weekly Commentary: Higher bar for U.S. earnings to deliver
Earnings in view
U.S. stocks have slid from their highs as inflation proves sticky and geopolitical tensions rise. We eye whether corporate earnings can keep buoying sentiment.
Market backdrop
The S&P 500 slid 3% last week on jitters before key tech earnings results and rising bond yields. Geopolitical flare-ups are keeping oil prices elevated.
Week ahead
We look to this week’s U.S. PCE release for any signs of acceleration or stubborn services inflation. We see inflation and interest rates staying higher for longer.
We saw 2024 as a year of two stories. First, cooling inflation and solid corporate earnings would support upbeat risk appetite. And later, resurgent inflation would come into view and disrupt sentiment. We stay overweight U.S. stocks yet are ready to pivot. The second leg may be playing out now, reinforcing our expectations for persistently high inflation. That raises the stakes for Q1 corporate earnings to buoy sentiment, in our view, just as higher bond yields add pressure to equity valuations.
Baking in higher-for-longer rates
S&P 500 valuations and interest rate expectations, 2021-2024
Forward looking estimates may not come to pass. Index returns do not account for fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from LSEG Datastream and Bloomberg, April 2024. Notes: The chart shows the forward price-to-earnings ratio for the S&P 500 and the market pricing of the fed funds rate in three years, based on SOFR futures.
We’ve expected inflation would be on a rollercoaster as the drag from falling goods prices faded and firm wage growth made services inflation stubborn. Yet the March pick-up in core services inflation shows that inflation is proving sticky. Further escalation of Middle East tensions could see oil prices staying elevated, reinforcing higher inflation and higher-for-longer interest rates. Sticky inflation has prompted markets to slash their expectations for Federal Reserve rate cuts to less than two this year (green line in chart) in line with our view. The Fed has gone from blessing market hopes for inflation to fall to 2% without a growth hit to implying policy may have to stay tight. The S&P 500 price-to-earnings ratio – a popular valuation metric – shows stocks feeling the heat from higher rates (orange line). We think that’s why it’s more crucial that companies keep meeting or beating high earnings forecasts.
We question whether the slide in stocks is a blip or a bigger shift toward pricing in inflation – and interest rates – settling higher than pre-pandemic. We stay overweight U.S. stocks on a six- to 12-month tactical horizon but are ready to pivot given that uncertainty. We have broadened out our stock view to include segments of the market with an improving earnings growth outlook. And we have leaned against small cap stocks whose earnings are at greater risk from higher rates. Earnings face a critical test this week, with some mega cap tech companies reporting. With stocks under pressure and rate cut hopes fading, we think the bar is higher for tech firms to deliver on earnings expectations – and for other sectors to show an earnings recovery. Confirmation of inflation settling higher and earnings misses could trigger a change to our view.
Moving up the tech stack
We still prefer artificial intelligence (AI) beneficiaries to tap into the AI and digital disruption mega force – a structural shift driving returns now and in the future. We went overweight early AI winners and enablers like chip and hardware makers in 2023. That view paid off as some valuations soared above historical averages. We are eyeing potential winners further up the technology stack – the layers of technology needed to develop AI applications – and beyond as AI adoption spreads. That’s the case in healthcare, financials and communication services, sectors we like because they have more scope for productivity gains. Outside of tech, those sectors have had some of the most mentions of AI-related keywords in earnings calls and company filings, BlackRock’s Systematic Equity team finds. AI mentions in non-tech sectors have soared 250% since 2022.
In fixed income, we stay neutral long-term U.S. bonds even as 10-year yields have risen this year. We think yields can swing in either direction as policy rate expectations shift in the near term. Long-term yields are moving toward our view that investors will demand more term premium, or compensation for the risk of holding long-term bonds in the long run. Term premium is muted for now. We prefer short-term bonds, euro area high yield credit and emerging market hard currency debt for income.
Our bottom line
U.S. earnings updates this week will be key to see if they can keep topping expectations and buoying risk appetite in a higher-for-longer interest rate environment. We’re overweight U.S. stocks and see the AI theme broadening.
Market backdrop
The S&P 500 slid 3%, led by tech, on jitters before key earnings results this week and rising bond yields. The first direct strikes between Iran and Israel also helped stoke market unease. U.S. 10-year Treasury yields hit a new 2024 high of 4.70% before settling back slightly. Oil prices eased 4% last week after having been pushed higher due to geopolitical unrest in recent months. We think we’re in a world of structurally higher geopolitical risk – and a lower threshold for conflict escalation.
We’re watching this week’s release of March U.S. PCE data, the Federal Reserve’s preferred measure of inflation, for any signs of acceleration or stubborn services inflation. U.S. CPI data showed that core services inflation, excluding housing, ramped up in March – signaling that inflation may not fall as much as markets expected. Elsewhere, we don’t expect the Bank of Japan to hike rates. Markets will likely focus on its updated economic projections and CPI data.
Week ahead
April 23
Global flash PMIs
April 24
U.S. durable goods; Japan services PPI
April 25
U.S. GDP data
April 26
U.S. PCE; Bank of Japan policy meeting; Japan CPI
Source
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 April 18, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date 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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