Wealth managers argue against chasing the recent market rally despite S&P 500 companies beating analysts’ earnings estimates.

Wealth managers argue against chasing the recent market rally despite S&P 500 companies beating analysts' earnings estimates.

Resilient Earnings in the Face of Uncertainty

Earnings Report

In what can only be described as a remarkable display of resilience, corporate America has managed to outperform Wall Street’s expectations during the second quarter earnings season. Despite a challenging economic environment and concerns of slowing growth, large U.S. companies have navigated through the uncertainty and delivered solid results.

Out of the firms in the blue-chip index, 87% have reported earnings, and they have beaten Wall Street’s admittedly low EPS targets by an average of 2%, according to Bank of America. This performance puts them on track for a more muted EPS decline of 4% to 5%. A total of 70% of the 423 companies that reported earnings managed to exceed Wall Street’s EPS forecasts, while 60% surpassed sales estimates.

While the earnings season has been strong, it is interesting to note that investors have responded with somewhat muted reactions. Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, highlights the negative skew of reactions, particularly in growth stocks. Even companies that guided for rising earnings saw their stocks fall by an average of 0.05% the day after reporting, compared to the historical average rise of 1.93%.

Dylan Kremer, Certuity’s co-chief investment officer, points out that the earnings momentum of the S&P 500 aligns well with analysts’ forecasts. Corporate America had anticipated a steep drop in earnings this quarter, leaving them room to outperform. Despite beating Wall Street’s consensus forecasts, the expected aggregate earnings decline for the second quarter still sits at -5%. Nonetheless, Kremer emphasizes the overall strength of the earnings season, highlighting how large U.S. companies have successfully navigated the challenging economic environment thus far.

One factor contributing to the positive sentiment is the fading inflation and steady job growth experienced in the U.S. These factors have led executives to feel more optimistic recently. BofA’s Subramanian notes that her three-month guidance ratio, which measures the ratio of companies offering above- versus below-consensus earnings guidance, jumped to 1.3x last week. This is the highest level since 2021 and significantly above the historical average of 0.8x. Furthermore, BofA’s analysis of earnings transcripts indicates that sentiment improved in the second quarter, with a five percentage point year-over-year increase, marking the largest jump since the third quarter of 2021.

A Word of Caution

Despite the stronger than anticipated second-quarter earnings, a hot labor market, and increasingly bullish executives, wealth managers remain cautious about the stock market’s future. The S&P 500 has already seen an impressive increase of nearly 18% year-to-date. However, with aggregate earnings on track to decline by 5%, concerns arise about how much more can go right.

Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, raises an important question: “How much more can go right?” She points out that while anything is possible, economic strength suggests that interest rates will be higher for longer, making rich multiples unsustainable. Furthermore, she warns that tailwinds experienced in 2023 may reverse as excess consumer savings are exhausted, demand cools, fiscal spending decelerates, and liquidity shifts.

In response to these concerns, Shalett recommends her clients trim their exposure to the most richly valued U.S. stocks. She is not alone in this sentiment. Ryan Belanger, founder and managing principal at Claro Advisors, also advises caution, emphasizing the importance of remaining vigilant and not becoming complacent in the face of the market’s inflation and Federal Reserve fears.

Belanger reminds investors to resist the temptation of buying into this recent market rally, as fears of missing out may drive them to make impulsive decisions. Instead, he believes it is too early to consider adding new money at current valuations.

In conclusion, while the second-quarter earnings season has showcased the resilience of large U.S. companies, caution remains among wealth managers. The market’s strong performance and concerns about inflation and the Federal Reserve call for a careful approach in investment decisions. As uncertainty lingers, it is crucial for investors to remain informed and adaptable in their strategies.