Investors Look for Reasons the Market Could ‘Grind Higher’

As companies prepare to open up their books to investors over the next few weeks, in a quarterly ritual known as earnings season, market watchers are split between relatively weak expectations for past earnings and upbeat expectations for future earnings. balanced.

Stocks have tended to follow future earnings expectations rather than react to past details, and the market has risen in step with investors’ improving economic outlook. The S&P 500 index has risen more than 20% since October.

Companies in the index are expected to see a 7% decline in earnings in the three months to June compared with the same period last year, according to FactSet. But much of that decline was concentrated in a few sectors, such as energy, which posted huge gains last year, making comparisons to this year difficult. Corporate executives also tend to lower investor expectations ahead of earnings reports so they can beat expectations.

“The earnings cycle may already be bottoming out,” said Binky Chada, chief U.S. equity strategist at Deutsche Bank.

The bleak predictions of the beginning of the year were not met. The economy remains resilient despite widespread fears of a recession. The latest inflation report released this week casts optimism that the Federal Reserve may be able to keep inflation in check without sending the economy as a whole—and American businesses—into a deeper recession. urged.

The strength of consumer spending underpins the resilience of the economy, and the focus will be firmly on how households are holding up as savings accumulated through the pandemic dwindle. But even here, many big companies have already managed to raise prices significantly, softening the impact of a potential consumer downturn.

This year, Pepsi said it had already raised prices enough to cushion rising costs for the rest of 2023. On Thursday, the company reported a further 15% price hike in the three months to June, reflecting continued consumer demand. It absorbs higher prices and the willingness of companies to take advantage of them.

“It’s encouraging that consumers still seem pretty resilient,” said Goldman Sachs analyst Bonnie Herzog.

Pepsi Chief Executive Ramon Laguarta told analysts Thursday morning that a strong job market in the U.S. and abroad is helping consumers. Labor Department data released last week showed the unemployment rate remained low even as the economy cooled.

Some of the companies hit hardest by the pandemic, including cruise lines Royal Caribbean and Carnival Cruise Lines, are also starting to bounce back.

Analysts had expected Pepsi to report strong results, but the company still beat expectations, with shares up 2.4% on Thursday. Over the past decade, more than 70% of companies have beaten analyst expectations on average, according to FactSet.

Investors are already ignoring the 2.1% drop in earnings in the first quarter, even if some companies start to slump, which proved better than the more than 6% drop expected. ing.

This bright result contributed to the rise in the S&P 500 index. At the beginning of the year, the average analyst expected the S&P to rise about 5% in 2023, according to Bloomberg’s tally of forecasts. It took me less than a month to break through that level.

Since then, forecasters at Bank of America, Goldman Sachs, BMO and others have raised their hopes.

For the first time this year, John Flood, head of U.S. equity sales and trading at Goldman Sachs, asked in a memo to clients for the first time this year whether the S&P 500 index could hit a new all-time high in 2023. said he answered. percent apart. “I go with yes,” he wrote.

Still, much of the bullishness about resuming earnings growth is already embedded in the bull market, and few analysts expect the index to rise further from here.

Some, including analysts at Kantar, Morgan Stanley, BNP Paribas and Barclays, continue to expect a decline of around 10% or more by the end of the year.

The sharp rise in the S&P 500 index since hitting lows in October means that corporate valuations are already at historically high levels. Although the unemployment rate remains low, there are signs of softening in the labor market. Pepsi reported strong earnings and raised prices, but sales suffered as a result as some consumers were put off by the high prices.

Some analysts said the end of the moratorium on student loans meant that loan repayments would resume in the fall, creating another headwind for consumers.

Aside from the tech companies that have boosted the market, partly due to enthusiasm for the potential benefits of artificial intelligence, companies may face further resistance to rising prices while costs such as wage increases remain. said Venu Krishna. Head of US Equity Strategy at Barclays.

“The earnings pressure is still there,” he said.

Even some of the more optimistic strategists say the worst for corporate earnings may soon be in their rearview mirrors, but much of the recent optimism is already baked into the market, so stocks will continue to climb. is going to be even more difficult.

Still, the outlook for the latest earnings round is a far cry from the grim forecasts at the beginning of the year, and Chada still expects the stock to “go higher.”

“There are a lot of concerns that investors have, and whether we will have a recession is an open question,” he said. “However, given the long-rumored potential for a recession, which is expected to be mild, we believe the market downturn will be modest and short-lived.”

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