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Keeping the Stock Market Rising Requires Better Earnings. It’s Not Going to Get Them, warns JPMorgan

January 22, 2024
minute read

The beginning of the week sees futures markets indicating that the S&P 500 is poised to achieve a new record. However, the anticipation of fresh peaks prompts some market participants to exhibit early signs of acrophobia, manifesting as concerns about the rapid ascent and worries about valuations.

Addressing valuation concerns, corporate earnings announcements become a potential remedy, and conveniently, the market is entering a more active phase of the corporate reporting season. Investors experiencing trepidation would seek reassurance from robust numbers and optimistic forecasts.

"The good news is that the hurdle rate has come down aggressively," notes Mislav Matejka and the equity strategy team at JPMorgan. According to the JPMorgan team's note dated Sunday, projections for fourth-quarter S&P 500 aggregate earnings per share are $4 lower than those achieved in the third quarter. The year-on-year growth rate has decelerated from 10% to a mere 2%.

Matejka suggests that, given these projections, actual results are likely to surpass the lowered estimates once again. However, a challenge arises – for the market to advance further, it necessitates more than just beating earnings estimates at these reduced levels. The market requires net earnings upgrades.

Why is this important? In Matejka's perspective, investor sentiment appears overly complacent, with positioning significantly higher than observed throughout the previous year. Valuation multiples have also risen, transitioning from a price/earnings ratio of 17.5 for the S&P 500 in the past year to the current 20.

Moreover, the primary driver of the last quarter's rally, the decline in bond yields, is likely concluded for the time being. A cause for concern is that early reports indicate that companies beating earnings estimates are not experiencing improved stock performance. In fact, Matejka notes that, so far, the average stock surpassing forecasts has lost 1% on the day.

JPMorgan expresses apprehension that the downtrend in earnings momentum persists, given indicators such as waning activity in purchasing managers' surveys, potential weakness in the job market, and companies grappling to maintain elevated profit margins.

The situation is even more challenging in Europe, where Matejka notes that "profit margins are elevated vs. typical, higher than what was the case pre-COVID for nearly 75% of them." He suggests that COVID distortions have disproportionately favored cyclicals, and a correction in this trend may occur.

Consequently, Matejka believes that defensive stocks will outperform in 2024. He maintains an overweight position on growth versus value, favoring the U.S. over the eurozone.

A potential headwind for the U.S. market lies in semiconductor stocks, which have experienced a robust rally over the past year, deviating from key fundamental drivers. Matejka suggests that this gap might begin to close.

In terms of market indicators, U.S. stock-index futures are higher as benchmark Treasury yields decline. The dollar remains relatively unchanged, while oil prices exhibit a slight firmness, and gold trades around $2,020 per ounce.

Looking ahead, seventy-nine S&P 500 companies are set to release their results this week. Notable earnings announcements include Logitech International, United Airlines, and Zions Bancorp.

The U.S. economic leading indicators report for December is scheduled for release at 10 a.m. Eastern.

Several developments in individual companies include Boeing facing lower stock prices after the Federal Aviation Administration recommends additional inspections for certain aircraft models. Archer Daniels Midland shares are down over 9% in premarket trade following news that its chief financial officer has been placed on administrative leave amid an investigation into accounting practices in its nutrition segment. Macy's rejects an unsolicited bid to go private in a $5.8 billion deal from Arkhouse Management and Brigade Capital Management.

In political news, Ron DeSantis opts out of the presidential race, endorses Trump, and misquotes Churchill.

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