Despite the Federal Reserve’s aggressive approach to combat inflation, stocks have remained surprisingly resilient. Wall Street strategists attribute this to a stronger-than-expected earnings season for the first quarter of 2024.
With 80% of S&P 500 companies reporting results, the index is on track for a healthy 5% growth in earnings per share. This surpasses analysts’ earlier forecasts of 3.2% growth, marking the biggest year-over-year increase since mid-2022.
“Higher interest rates usually hurt U.S. stock valuations,” notes Jean Boivin, head of the BlackRock Investment Institute. “Yet, strong Q1 earnings have cushioned stocks, even as rising rates and expectations could potentially dampen market optimism.”
Initial Analysis: The surprising resilience of the stock market in the face of the Federal Reserve’s aggressive interest rate hikes suggests a disconnect between rising costs of borrowing and corporate profitability. This resilience indicates that corporate earnings in the first quarter of 2024 have surprised analysts and investors by exceeding initial expectations.
Earnings Factor: It seems that strong earnings results are providing a buffer against concerns about tighter Fed policy. Investors are willing to pay a premium for stocks displaying earnings resilience even in a higher interest rate environment. This may stem from the view that such companies can weather economic headwinds better than those facing profitability struggles.
Bullish Wall Street strategists see solid earnings growth as a key driver behind the index’s 8% rally this year, with the potential for further gains ahead. Net profit margins, currently on track for 11.7% growth in Q1, have exceeded both the five-year average and last year’s figures. Notably, this boost stems largely from cost-cutting measures rather than surging revenues.
The tech sector initially demonstrated the power of reducing expenses in 2023, and now companies beyond tech are adopting the same strategy. This sets the stage for wider earnings growth within the index moving forward.
While the technology sector was initially the leader in aggressive streamlining measures in 2023, the trend of cost-cutting to enhance profit margins has now expanded across diverse industries. This could signify an overall shift in corporate strategy as companies look to maintain earnings growth even with relatively flat revenue.
Implications: The broad embrace of cost-cutting signals the potential prolonging of higher interest rates, as companies might feel less urgency to boost sales and revenue with cheaper debt.
Analysts Remain Optimistic
Perhaps the most striking shift comes in the outlook for Q2 earnings. While 55% of companies have offered guidance lower than analyst estimates, the overall sentiment remains surprisingly upbeat. Analysts themselves have been revising earnings per share projections upwards for S&P 500 companies, a departure from the usual downward revisions seen during quarters.
DataTrek co-founders Jessica Rabe and Nicholas Colas see this as a “bullish development,” suggesting that “even with all the uncertainty around monetary policy, it is hard to see US large caps falling very much when estimate revisions are positive.”
The upward revision of earnings per share projections for S&P 500 companies is a stark departure from typical trends in uncertain economic climates. This indicates that analysts are factoring in the robust earnings reports and resilient cost control measures.
Companies might be demonstrating the ability to adapt to evolving market conditions, leading to a more positive outlook from analysts. For instance, a consumer goods company shifting to a mix of premium and value product lines could be viewed as a hedge against inflation and thus be reflected in brighter forecasts.
While analyst optimism is a good sign, investors should remember that forecasts can change quickly due to unexpected events. Economic indicators and future company guidance should also be closely monitored.
Granted, an external shock could always disrupt the market. But the positive earnings picture offers substantial resilience against fears of prolonged high-interest rates. It appears that cost-cutting strategies and a cautiously optimistic outlook from analysts are fueling a more widespread market rally than previously anticipated.
Although interest rates could climb further, the market’s resilience suggests investors are focusing on underlying company performance. Earnings exceeding expectations are a testament to corporate America’s ability to navigate challenging times.
Cost-cutting measures and strategic adjustments are helping companies maintain profitability and are proving to be more powerful than initial fears of rising rates.
As long as companies maintain earnings strength, and analysts remain cautiously optimistic, the market could experience further upward movement. This highlights the vital importance of closely following earnings reports in the future — and using your best judgment when it comes to the fundamentals of a balanced portfolio.