Earnings Are Last Pillar of Equity Strength as Rate Cuts Recede

A hotter-than-expected inflation print Wednesday morning all but removed the possibility of interest rate cuts in the near future. That leaves earnings as a last leg of support for the resilient stock market rally that began last year.

And Corporate America could very well deliver on that promise.

Wall Street strategists are optimistic about another bumper earnings season as global economic growth picks up. Even pricey technology stocks — the primary profit engine in the previous quarter — are again expected to be supported by solid results. So while the S&P 500 Index is struggling in April after its best first quarter in five years, few experts are eager to bet against this market.

“It’s way too early to apply the brakes on the US stock rally,” said Manish Kabra, head of US equity strategy at Societe Generale SA. “The momentum has been backed up by the earnings outlook, and I expect that to continue for at least one more quarter.”

Kabra is among a slate of Wall Street strategists who have boosted their year-end forecasts for the S&P 500 in recent weeks.

Earnings for S&P 500 companies are expected to post a “healthy” 10% gain in the first quarter in headline numbers from a year ago, according to Deutsche Bank AG strategists led by Parag Thatte. And earnings upgrades from analysts have outnumbered downgrades in the first quarter, according to a Citigroup Inc. index.

“There’s a likelihood that Q1 earnings season is still going to be pretty strong, especially given just how strong economic growth was in the first quarter,” said Cayla Seder, macro multi-asset strategist at State Street.

The rising profit forecasts lessen worries that that the broad equities benchmark is in a bubble. After a 9% rally this year, S&P valuations are well above their 20-year average and the index is already about 4% higher than the average target of strategists tracked by Bloomberg last month.

Meanwhile, investors are buying in, as allocations to stocks have surged since an October low on the back of upbeat projections for economic growth, according to Deutsche Bank. Exposure is now expected to flatline as companies go into a blackout period for stock buybacks ahead of the reporting season. But the levels are not high enough to warrant a selloff in the absence of a negative catalyst, a team at the firm led by Thatte wrote in a note.

Other strategists concur. Confidence among equity investors is at the highest in nearly two years, but sentiment is still far from the “euphoric” levels that typically signal a top, Bank of America Corp. strategist Savita Subramanian said earlier this month.

“When we talk about sentiment, my underlying view is that whether sentiment is really negative or whether sentiment is really positive, sentiment can stay in either direction so long as the information circumstance is as it is,” said Citigroup strategist Scott Chronert.

There is, of course, skepticism brewing among some market participants after Federal Reserve officials last week raised the possibility of keeping interest rates high for longer than expected. Those comments sparked the biggest one-day selloff in the S&P 500 in almost two months last Thursday. The volatile week also prompted long-complacent traders to look at the hedges they’ve ignored for months.

The stock market’s tepid start to April has led JPMorgan Chase & Co. clients to question whether the rally has peaked and if the recent price action portends something “much worse in the economy,” said Andrew Tyler, head of US market intelligence at the bank, in a note. However, he isn’t convinced.

“I think none of these,” Tyler wrote to clients. “It is possible that we could see a 2-3% pullback, but you need to see either deterioration in the macro story or an earnings season that shows negative sequential growth.”

The reversal in stocks on Friday following a hotter-than-expected US jobs report also shows how eager traders are to buy into any pullback.

Additionally, forecasts for tech earnings remain strong, with analysts expecting the sector to report that profits soared 20% in the first quarter. At the same time, the outlook for the more economically sensitive sectors is brightening, suggesting a broader, healthier rally as the laggards catch up.

For Charlie Ashley, portfolio manager at Catalyst Capital Advisors LLC, the stock market’s fate hinges on these projections.

“Multiples are extended right now, so earnings strength needs to continue,” Ashley said. “If there is softness in earnings, that’s going to be a warning signal because that’s likely followed by a weakening US consumer and a weakening economy.”

(Adds inflation context in first three paragraphs.)

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