Market Outlook

May 1, 2024

Earnings Still Matter Most


John Bonnanzio In this space last month, I argued that high federal deficit spending is a contributor to the Fed’s inability to cool inflation to its long-term target of 2%. While it will be a long time before I’m proved right or wrong, last month’s economic data dump certainly made it clear that the Fed’s inflation battle is far from over.

Let’s review some of the more troubling details.

For starters, CPI rose 0.4% in March, a slight rise over the prior month’s increase of 0.3 percentage points. However modest that was, Wall Street (and many others) have been counting on inflation to further cool, thereby giving the Fed the breathing room to reduce its current interest-rate-range of 5.25% - 5.50%.

But with the combination of the 12-month CPI backing up to 3.5% (above the consensus estimate of 3.2%), the Fed’s favored core personal consumption expenditures index rising 2.8% (from a year ago), the producer price index increasing 2.1% (its biggest rise since last April), and you wind up with the much-anticipated spree of second-half rate-cuts suddenly becoming unlikely. Needless-to-say, investors took notice: the so-called fear index jumped higher and share prices stumbled, then tumbled.

Fed Funds Vs. Inflation

Ultimately shoring up share prices, however, was first-quarter earnings. Although earnings season is only halfway done as of this writing (with some bellwether names yet to report), it appears that many of America’s largest companies both beat expectations and provided shareholders with upbeat forward guidance.

FactSet expects the S&P 500 to show earnings growth for the third straight quarter. Seventy-seven percent have reported earnings-per-share (EPS) results averaging 8.4% above expectations.

And there’s more good news on that front: Above-estimate EPS gains haven’t been limited to the tech sector. In fact, the largest contributor to earnings by sector has been communication services, followed by financials, industrials and tech. In the aggregate, current results suggest first-quarter earnings growth of 3.5%; that would top the 3.4% growth rate from a year ago.

Stagflation Fears
Given the election cycle and the fact that there is plenty of data to suggest the economy is either faring okay, or it’s poised to slow, “stagflation” has become a highly politicized term. Yes, the economy is growing only slowly. On the other hand, unemployment is a low 3.8% (up from 3.4% a year ago), and real wage gains have helped to keep workers one step ahead of inflation.

Against that backdrop, most should agree that FactSet’s projected year-over-year earnings growth rates of 9.7%, 8.6%, and 17.2% for Q2 2024, Q3 2024 and Q4 2024, respectively, is very promising.

Of course, the S&P 500’s 4.1% decline in April suggests otherwise.

While one survey of consumer confidence shows that Americans are generally positive, an Expectations Index indicates that they’re less optimistic about the future. In fact, if survey results are in keeping with history, they may be signaling a forthcoming recession.

In the absence of better-than-expected first-quarter earnings and promising forward guidance, April’s stock decline would likely have been far worse. It may also have been even less had a certain politician not suggested raising corporate and individual tax rates. Nor would stocks have retreated as much had they not risen 26% last year and 10.6% last quarter — gains that baked in expectations of significant rate cuts and lower inflation.

As it can be argued that stocks have been priced to perfection, and that they may soon wax and wane with all the usual campaign theater, it’s important to remember that over the long term, share prices follow earnings. So absent substantial downward earnings revisions, your current equity allocation should still meet your long-term goals.

— John Bonnanzio