Investors Look for Reasons the Market Could ‘Grind Higher’

Investors Look for Reasons the Market Could ‘Grind Higher’ [ad_1]

As companies prepare to open their books to investors over the coming weeks, in the quarterly ritual known as earnings season, market watchers are balancing relatively weak estimates for past profits with brighter forecasts for future performance.

Stock prices tend to follow expectations of earnings to come rather than react to details about the past, and markets have risen in step with investors’ improved outlook for the economy. The S&P 500 index has gained more than 20 percent since October.

Companies in the index are expected to report a 7 percent slide in earnings for the three months through June, compared with the same period last year, according to FactSet. But much of that decline is concentrated in a few sectors, like energy, that recorded outsize profits last year, making for difficult comparisons to this year. And corporate executives also have a habit of lowering investors’ expectations ahead of earnings announcements, so that they can beat projections.

“The bottom for the earnings cycle may already be in,” said Binky Chadha, the chief U.S. equity strategist at Deutsche Bank, who correctly predicted, against the consensus, that stocks would rally this year.

Gloomier predictions at the start of the year have not played out. Despite widespread fears of a recession, the economy has remained resilient. The latest report on inflation, released this week, prompted optimism that the Federal Reserve may yet tame soaring prices without dragging the broader economy — and corporate America — into a deeper downturn.

With the strength of consumer spending underpinning economic resilience, focus will be firmly on how households are faring, as savings built up through the pandemic dwindle. Even here though, many large companies have already managed to raise prices significantly, softening the impact of any consumer weakness that may be yet to come.

This year, Pepsi said that it had already increased its prices enough to mitigate rising costs for the rest of 2023. On Thursday, the company reported that for the three months through June, it raised prices another 15 percent, reflecting consumers’ continuing ability to absorb higher prices, and companies’ willingness to exploit it.

“It’s encouraging that still the consumer seems to be pretty darn resilient,” said Bonnie Herzog, an analyst at Goldman Sachs.

Ramon Laguarta, the chief executive of Pepsi, told analysts Thursday morning that a strong job market in the United States and abroad had helped consumers. Data released by the Labor Department last week showed that even as the economy had cooled, unemployment remained low.

Even some of the hardest hit companies through the pandemic, such as the cruise operators Royal Caribbean and Carnival Cruise Line, have begun to bounce back.

While analysts had predicted Pepsi would post strong financial results, the company still exceeded expectations, lifting its stock price 2.4 percent on Thursday. Over the past 10 years, more than 70 percent of companies have on average exceeded analysts’ forecasts, according to FactSet.

Even if some companies do start to slip, investors have already shrugged off a 2.1 percent drop in earnings for the first quarter, with the fall proving better than the over 6 percent decline that was expected.

That rosier outcome has helped propel the S&P 500 higher. The average analyst at the start of the year forecast that the S&P would rise roughly 5 percent over the course of 2023, according to a Bloomberg aggregation of forecasts. It took less than a month to break through that level.

Prognosticators from the likes of Bank of America, Goldman Sachs and BMO have since raised their expectations.

John Flood, head of U.S. equities sales trading at Goldman Sachs, wrote in a note to clients on Wednesday that for the first time this year he had been fielding questions on whether the S&P 500 could hit a record high in 2023, which remains roughly 5 percent away. “I am going with a yes,” he wrote.

Still, only a handful of analysts expect the index to rise further from here, with much of the bullishness over the resumption of earnings growth already baked into the rally.

Some, including analysts at Cantor, Morgan Stanley, BNP Paribas and Barclays, continue to forecast a drop of around 10 percent or more before the end of the year.

The searing rally in the S&P 500 since it plumbed its low in October means companies are broadly already valued at historically high levels. While unemployment remains low, there are signs of softening in the labor market. Pepsi reported strong earnings and raised prices, but its sales volume took a hit as a result, as some consumers balked at the higher price tags.

Some analysts also pointed to the end of the student loan moratorium, meaning loan repayments will restart in the fall, as another headwind for consumers.

Aside from a group of technology companies that have driven the market higher, partly because of enthusiasm over the profit potential of artificial intelligence, companies could face more resistance to higher prices, while costs — such as from higher wages — remain, said Venu Krishna, head of U.S. equity strategy at Barclays.

“We still see ongoing earnings pressure,” he said.

Even some of the more optimistic strategists acknowledge that while the worst for company earnings may soon be in the rearview mirror, it will be more difficult for stock prices to keep rising because much of the recent optimism is already embedded in the market.

Still, the outlook heading into the latest round of financial results remains far from the dour predictions at the start of the year, with Mr. Chadha expecting stock prices to still “grind higher.”

“There are a long list of concerns that investors have, and whether or not we go into a recession is an open question,” he said. “But with the potential recession long telegraphed and expected to be mild, we think the market sell-off will be modest and short-lived.”

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