LDN - Business

US stocks' lofty valuations in spotlight as earnings season nears

[April 06, 2024] By David Randall and Lewis Krauskopf

NEW YORK (Reuters) - The U.S. stock market is the most expensive it has been in around two years. Its valuation could be put to the test as companies report earnings in coming weeks.

The S&P 500 is up more than 9% year-to-date, following its strongest first-quarter performance since 2019. But the bar may be rising for stocks to keep advancing at that pace, increasing pressure on companies to deliver strong results.

The benchmark index trades at 20.7 times its estimated earnings for the next 12 months, near a more than two-year high of 21.2 hit in late March, according to LSEG Datastream. Unremarkable earnings growth could give investors less reason to hold onto stocks, at a time when elevated yields on Treasuries bolster the attractiveness of bonds.

Investors will also listen for companies’ views on the economy and inflation, to gauge whether the so-called Goldilocks environment of resilient growth and cooling consumer prices can continue.

Signs of stubborn inflation have diminished expectations in recent weeks for how deeply the Federal Reserve will cut rates this year. Stocks rose after another stronger-than-expected employment report on Friday.

“If we're going to continue to make significant gains in the stock market, we have to not just meet, but probably exceed ... what those estimates are for earnings,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management.

Delta Air Lines, BlackRock, and JPMorgan Chase & Co are among the companies scheduled to release their first quarter results next week. Investors will also be watching for March U.S. consumer price data, expected on April 10.

Analysts expect to see earnings growth of 5% in the first quarter, according to LSEG data. That would be the lowest since the second quarter of 2023. They expect margins to be squeezed by high interest rates, rising commodity costs, and falling corporate pricing power due to slowing inflation. Earnings grew by 10.1% in the fourth quarter of 2023.

The results of megacaps such as Nvidia, Meta Platforms and Microsoft could be key for investor sentiment, following a divergence in the share price performance of the so-called Magnificent Seven stocks that led markets higher last year.

Chipmaker Nvidia, for instance, is up 78% in 2024, while Tesla shares have fallen over 30% due to concerns over its margins and demand. The electric vehicle maker has canceled the long-promised inexpensive car that investors have been counting on to drive its growth into a mass-market automaker, Reuters reported on Friday.

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A trader works on the trading floor at the New York Stock Exchange (NYSE) in New York City, U.S., April 5, 2024. REUTERS/Andrew Kelly

"These businesses now need to justify these high valuations," said Bryant VanCronkhite, a portfolio manager at Allspring Global Investments. "The market is looking for every company to talk about their demand drivers and articulate what they see coming ahead."

At the same time, investors will be watching whether evidence of continuing strength in the U.S. economy flows through to rising revenues and earnings for industrial, energy, and other sectors that are closely tied to growth. Shares of these companies have largely performed well this year in a rally that has spread beyond technology and growth names.

“If the U.S. economy starts to bounce from here you want exposure to industries with real economy end-markets," said Justin Menne, head of US equities for Harbor Capital Advisors, who is overweight shares of energy companies.

Liz Ann Sonders, chief investment strategist at Charles Schwab, said she expects “punishment” of companies that fail to meet expectations.

"What will be critical beyond the beat rate will be the margin stories," she said.

As always, the Fed will loom large in investors’ minds. A robust earnings season and expectations of growing price pressures from companies could be seen as further evidence that the economy is too strong for the central bank to cut rates without risking an inflationary rebound.

March U.S. employment numbers backed up that narrative. Nonfarm payrolls increased by 303,000 jobs last month, far above expectations. Futures markets show investors expect the Fed to deliver around 70 basis points of rate cuts this year, compared to 150 basis points they had factored in January.

Yet weaker earnings could indicate cracks in the economy’s strength. Some investors believe that could boost the case for the Fed to ease monetary policy.

"That bad news could actually be good news for the market because it leads to those Fed rate cuts that everyone is hoping for,” said Kevin Mahn, chief investment officer at Hennion & Walsh Asset Management.

(Reporting by David Randall and Lewis Krauskopf; Editing by Ira Iosebashvili and David Gregorio)

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