Analysis-As earnings support U.S. stock rebound, worries over future profits grow

By Lewis Krauskopf

NEW YORK (Reuters) – Stronger-than-expected company earnings have helped gas the rebound for U.S. shares however some traders are pointing to potential dangers forward for income that would sap the market’s momentum.

With the overwhelming majority of S&P 500 corporations reported, second-quarter earnings are anticipated to have climbed 9.7% from a 12 months earlier, nicely above the 5.6% estimated on July 1, in keeping with Refinitiv IBES. The strong income have supported a rally that has taken the S&P 500 up about 14% this quarter, after a brutal first half.

Some market individuals are rising involved, nonetheless, that sturdy company numbers might not final, as corporations face an array of challenges, together with surging inflation and altering shopper spending habits. These might make it troublesome for shares to carry their current features or rise additional, they mentioned.

“There may be some draw back to earnings going ahead and it is revolving round inflation and the power of corporations to move on these rising prices,” mentioned Paul Nolte, portfolio supervisor at Kingsview Funding Administration.

“I might suppose the subsequent leg (greater) goes to be a little bit bit tougher” for shares, he mentioned.

Analysts’ estimates for full-year revenue progress have edged decrease because the begin of July, however nonetheless name for stable progress — 8% in each 2022 and 2023, in keeping with Refinitiv.

Strategists at fund administration big BlackRock, nonetheless, are amongst those that consider the market’s views are overly optimistic.

One motive is a shift in shopper spending from items to companies that they consider will weigh on S&P 500 income.

Whereas items make up lower than a 3rd of gross home product, earnings tied to items are anticipated to account for 62% of S&P 500 earnings this 12 months, BlackRock mentioned.

“This implies a increase in companies would not energy S&P 500 earnings as a lot because it does the economic system,” they wrote on Monday.

Overstocked inventories at corporations akin to retailers and semiconductor producers present that such a development is already underway, they mentioned.

“The danger of disappointing earnings is one motive we’re tactically underweight shares,” BlackRock mentioned.

Graphic: S&P 500 earnings progress, by quarter https://graphics.reuters.com/USA-STOCKS/RESULTS/movangdzxpa/chart.png

Earnings expectations are “remarkably sturdy” given headwinds akin to slowing progress in China and an inverted U.S. Treasury yield curve, which regularly precedes a recession, mentioned Jack Ablin, chief funding officer at Cresset Capital.

He stays “barely underweight” equities, regardless of the current rebound. Nolte, of Kingsview, has been including to inventory positions in portfolios he manages though he’s nonetheless beneath his benchmark allocation.

Morgan Stanley’s strategists, in the meantime, are centered on the prospect of weakening revenue margins. Total analyst estimates name for corporations’ working margins at all-time highs subsequent 12 months, they famous.

“The mixture of sustained, greater wage prices and slowing finish market/shopper pricing loudly indicators margin stress, which is at odds with optimistic consensus estimate,” they wrote Monday.

The agency believes downward earnings revisions are going to speed up over the subsequent two months, based mostly on historic information going again to 1996.

On the identical time, rising valuations may set the next bar for earnings to come back in sturdy sufficient to justify the elevated costs. The ahead price-to-earnings estimate for the S&P 500 has risen to about 18 instances after falling beneath 16 instances in June, in keeping with Refinitiv Datastream. The ratio remains to be nicely beneath the almost 22 instances stage reached firstly of the 12 months.

For now, nonetheless, corporations have continued to point out better-than-expected energy in earnings. Walmart on Tuesday nudged up its annual revenue forecast, partly reversing a hefty reduce lower than a month in the past, whereas House Depot’s quarterly gross sales surpassed estimates after demand from builders and better costs helped it cushion a success from dwindling retailer visits.

Certainly, some market watchers consider the upbeat earnings developments will proceed.

Citi strategists mentioned in an Aug. 12 observe that earnings revision developments had improved up to now in August versus the earlier month.

“The stabilization in revisions is encouraging,” Citi mentioned within the observe. “Nevertheless, 2023 estimates haven’t labored decrease in tandem so there should still be some threat to out 12 months estimates.”

(Reporting by Lewis Krauskopf; Enhancing by Ira Iosebashvili and Richard Pullin)