(Bloomberg) -- Investors have had plenty to cheer this earnings season so far — resilient consumer spending, upbeat Big Tech results and confident economic outlooks from corporate executives. Yet, the stock market is not reflecting the optimism.
The sharp US and European equities rally ahead of results stretched valuations and raised the bar for further gains, but worries about a recession and higher interest rates have capped sentiment.
With investors now preparing to hear from US industrials, automakers and retailers for further clues on the health of the consumer, here are four key takeaways from the season so far:
The US stock rally leading up to the season was at odds with the trend in the previous three quarters, when the market had sold off, according to Morgan Stanley strategists. That has made it difficult for equities to extend their advance amid concerns about a staunchly hawkish Federal Reserve and declining earnings, Morgan Stanley’s Michael Wilson, one of the most bearish voices on Wall Street, wrote in a recent note.
Even as nearly 81% of S&P 500 companies have beaten analysts’ estimates — the biggest proportion since the third quarter of 2021 — the median stock has outperformed the index by just 0.1% on the day of results, according to data from Bloomberg Intelligence.
In Europe, too, over 70% of firms have reported better-than-feared profit so far, but a rally in the Stoxx 600 Index has stalled.
“While first-quarter results are coming in better than expected, share prices have not rebounded as investors are increasingly concerned about delayed declines in fundamentals as a result of an impending recession,” said Sam Stovall, chief investment strategist at CFRA Research.
JPMorgan Chase & Co. strategists also warned that a better season may not lead to a sustained rally given the “strong run” in the preceding weeks.
An analysis by the team at Wells Fargo Securities LLC showed that companies beating profit estimates are outperforming the index by only 10 basis points, compared with an average of 73 basis points over 2022. The breadth has also narrowed, with 53% of beats outperforming this season, compared with an average of 58% last year, their data show.
“It is becoming an unforgiving market,” Wells Fargo strategist Christopher Harvey said. “We suspect this could point to signs of investor exhaustion.”
Solid Big Tech Results
Going into the season, analysts were forecasting the steepest drop in quarterly profits for US technology stocks since at least 2006. Early reports show those expectations may have been too pessimistic.
Heavyweights Microsoft Corp., Google-owner Alphabet Inc. and Facebook-parent Meta Platforms Inc. all delivered upbeat results last week, sparking a bounce in the Nasdaq 100 Index and calming worries that a 20% rally in the gauge had gone too far. Amazon.com Inc. also had strong results, although a downbeat outlook fueled a slide in its shares.
Read More: Microsoft, Alphabet Bring Relief for Earnings Angst: Tech Watch
Ron Saba, senior portfolio manager at Horizon Investments LLC, said that while cost cuts could continue to support tech earnings over the next few quarters, the outlook could darken beyond that.
“It’s difficult for companies to post strong earnings growth with such modest sales growth expectations,” Saba said.
Sustained Pricing Power
The impact of sticky inflation was seen as one of the main risks to earnings in the first quarter. But a range of companies, including Procter & Gamble Co. and Nestle SA, have been able to pass on higher prices as consumers prove willing to dip into pandemic-era savings despite slowing economic growth.
Mentions of pricing power in news articles are on the rise, while those of cost cuts are dropping, according to data compiled by Bloomberg. And with the likes of PepsiCo Inc. and Danone expecting demand to remain solid, a Citigroup Inc. index shows earnings downgrades are starting to slow.
Seasonality also stands to benefit the earnings outlook as most cuts to S&P 500 forecasts on average are done by April or May, said Lori Calvasina, head of US equity strategy at RBC Capital Markets. “While there is a lot of frustration among buy-siders that numbers haven’t come down enough yet for next year,” the trends so far in 2023 suggest “sell-side analysts have done a good job of pulling down numbers,” she wrote in a note.
That’s not to say all sectors have been able to sustain higher prices. Where consumer-goods firms have had a strong showing, Tesla Inc. has been among the most high-profile companies to announce cuts in recent months as competition in the electric-vehicle market heats up.
No Recession Alarms
The chorus of economists warning about a possible US recession has grown following recent turmoil in the banking sector. The tone among company executives, however, has been more “balanced” as they “acknowledged rising risks of a downturn but weren’t baking one in explicitly,” RBC’s Calvasina said.
While JPMorgan Chase Chief Executive Officer Jamie Dimon warned about the risks of a contraction in the world’s biggest economy, he said it won’t necessarily happen even if more US regional banks fail.
“I’m not surprised that there isn’t yet much broader pessimism about the outlook,” said James Athey, investment director at Abrdn. “The reality is that the job market looks very strong, therefore consumption is for now holding up well and CEOs don’t want to talk down their own stock or the economy.”
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