Stock Bulls Look To Earnings With Fed In A Corner: Markets Wrap

(Bloomberg) -- Stocks rose as a solid earnings season propped up the market despite bets the Federal Reserve will keep interest rates higher for longer.

After pulling back for the most part in April, equities staged a rebound toward the end of the month. Early results from the reporting season suggest that over 80% of US companies are beating expectations. First-quarter earnings are now on track to increase by 4.7% from a year ago, compared with the pre-season estimate of 3.8%, according to data compiled by Bloomberg Intelligence. 

Following strong results from its “Magnificent Seven” counterparts, Amazon.com Inc. is seen joining the pack this week with a jump in sales. Apple Inc. likely had a tougher time, with profit expected to be lower as iPhone sales slid. Chipmakers Advanced Micro Devices Inc. and Qualcomm Inc. probably eked out revenue growth.

“Last week, Big Tech enthusiasm outweighed concerns about sticky inflation,” said Chris Larkin at E*Trade from Morgan Stanley. “This week, we’ll find out if Amazon and Apple can keep that momentum going, but traders will also be taking the temperature of the latest jobs data and what the Fed has to say about inflation and rate cuts.”

The S&P 500 topped 5,100. Tesla Inc. soared 15% after receiving in-principle approval from Chinese officials to deploy its driver-assistance system in the world’s biggest auto market. Apple Inc. rallied on a bullish analyst call. Boeing Co. raised $10 billion from a bond sale that attracted about $77 billion of orders.

US 10-year yields fell five basis points to 4.62%. The Treasury ramped up its estimate for federal borrowing for the current quarter to $243 billion, more than most dealers had anticipated. The yen climbed on speculation Japan intervened to support its beleaguered currency for the first time since 2022.

Investors are faced with a call on whether the weakness in stocks seen earlier this month was only a blip or if delayed policy easing will pull the market back down again. The answer may lie in the market playbook of the 1990s, when equities more than tripled in value despite years of rates that were hovering around current levels.

“One of the important things investors learned last week is that the economy is less sensitive to interest rates in this cycle,” said Jeff Roach at LPL Financial. “The Fed is ‘backed into a corner’ as some sectors of the economy appear immune to interest rates.” 

At this rate, Roach expects the Fed to stay on hold longer than would happen in a normal cycle, “which increases the odds of either stagflation or a bumpy landing.”

Markets could remain volatile this week, but UBS’s Chief Investment Office continues to see the current environment as supportive for US equities — driven by solid earnings growth, a potential Fed pivot later this year, and accelerating artificial-intelligence investment.

“We remain constructive on US equities, and expect AI-related companies to drive strong earnings growth in the years ahead,” said Solita Marcelli at UBS Global Wealth Management. “It is key for investors to hold a healthy strategic allocation to tech stocks, but also advocate diversified exposure across regions and sectors.”

Meantime, Morgan Stanley’s Michael Wilson said the pressure from higher Treasury yields is taking the shine off an upbeat earnings season for Corporate America.

The strategist noted that although the share of companies beating analysts’ profit estimates was “strong,” the reaction in share prices was still muted as valuations were inflated following a record-breaking rally this year.

“While markets may enjoy the earnings results from the big tech companies, when earnings season is over, investors will be left justifying high market multiples in the face of interest rates that are likely to remain higher for longer,” said Megan Horneman at Verdence Capital Advisors.

The US stock market is likely to repeat the late summer swoon that kicked in last August, according to JPMorgan Chase & Co.’s Marko Kolanovic, who says the prospect of higher-for-longer interest rates weighing on growth poses a risk to this year’s rally.

“We remain concerned about the repeat of last summer’s drawdown, where the growth-policy tradeoff could move away from the Goldilocks narrative, together with a continued risk of concentration reversal, too steep projections for earnings acceleration this year, and positioning unwind.”

Since the October 2022 bear-market trough, stock gains have been driven mostly by multiples expansion linked to hopes for imminent Fed rate cuts and lower normalized rates — but the evolving narrative has been frustrating, according to Lisa Shalett at Morgan Stanley Wealth Management.

“While Fed pauses are typically supportive of stocks, long periods of ‘higher for longer’ can end poorly, with some part of the economy ultimately stressed, as with emerging markets in 1997, tech stocks in 2001 and housing/banking in 2007,” she noted. “This cycle’s candidates could be low-end consumers, small businesses dependent on credit and commercial real estate owners.”

“Equity markets have been in a sideways churn for two months as bulls and bears wrestle for control,” said Mark Hackett at Nationwide. “Following the dramatic run since October, a pause is not unexpected or unhealthy.”

He added that it is hard to see a dramatic breakout in either direction in the near term — as both sides have a compelling argument and expectations are not overly optimistic or pessimistic.

Despite concern that the Fed will be in no rush to cut rates, the appetite for technology stocks last week wasn’t lost on hedge funds. Tech saw the largest net buying since December 2022 by the group, driven by an increase in long positions and short-covering, data compiled by Goldman Sachs Group Inc.’s prime brokerage show. 

The dominance of the “Magnificent Seven” may soon give way to a broadening of earnings growth that is supportive of a variety of equity asset classes, according to Glenmede’s Jason Pride and Michael Reynolds.

In the fourth quarter, for instance, earnings growth from the group of megacaps is forecast to lag the rest of the market, with “equity analysts appear to be anticipating more abundant opportunities for profit growth beyond the market darlings,” they said.

The likelihood that rates will remain elevated for months to come has made a long-awaited rebound in the beaten-down stocks of smaller companies seem more elusive. 

Even as forecasts for policy easing are pushed out, sectors within the group poised to benefit from an economic recovery and with low refinancing risk are still well-positioned to outperform their large-cap counterparts, Bank of America Corp.’s strategists led by Jill Carey Hall said last week in a note.

Current multiples imply 9% annualized returns for the Russell 2000 over the coming 10 years, compared to just 2% per year for the Russell 1000, per BofA’s estimates.

Corporate Highlights:

• The Redstone family and independent film producer David Ellison have offered concessions to make a possible change in control at Paramount Global more appealing to the company’s other investors, according to a person familiar with the discussions.
• Domino’s Pizza Inc.’s same-store sales in the US exceeded first-quarter expectations, a promising sign for the company’s continued turnaround.
• SoFi Technologies Inc. gave guidance for second-quarter revenue and earnings that was less than analysts expected.
• WeWork Inc. and its major financial backers including SoftBank Group Corp. have struck a new restructuring deal to get the ailing workspace provider out of bankruptcy, spurning a competing financing proposal from co-founder Adam Neumann.
• The activist investor battling to replace Norfolk Southern Corp.’s leadership won the backing of Glass Lewis & Co., raising pressure on the railroad in the final days before a crucial shareholder vote.
• UMB Financial Corp. agreed to acquire rival Heartland Financial USA Inc. for about $2 billion in an all-stock transaction poised to be the year’s largest US regional-bank deal.
• Chinese automaker BYD Co.’s first-quarter revenue missed estimates as aggressive price cuts across most of its lineup ate into its financial performance.

Key events this week:

• Japan unemployment, industrial production, retail sales, Tuesday
• China Caixin manufacturing PMI, non-manufacturing PMI, manufacturing PMI, Tuesday
• Eurozone CPI, GDP, Tuesday
• US employment cost index, Conf. Board consumer confidence, Tuesday
• Amazon, Samsung, HSBC earnings, Tuesday
• Labour Day holiday across much of Europe, Wednesday
• Treasury’s quarterly refunding announcement, Wednesday
• US ADP employment change, JOLTS job openings, ISM Manufacturing, Wednesday
• Federal Reserve rate decision, Wednesday
• Eurozone S&P Global Manufacturing PMI, Thursday
• US factory orders, initial jobless claims, trade, Thursday
• Apple earnings, Thursday
• Eurozone unemployment, Friday
• US unemployment, nonfarm payrolls, ISM Services, Friday
• Chicago Fed President Austan Goolsbee speaks, Friday

Some of the main moves in markets:

Stocks

• The S&P 500 rose 0.3% as of 4 p.m. New York time
• The Nasdaq 100 rose 0.4%
• The Dow Jones Industrial Average rose 0.4%
• The MSCI World index rose 0.5%

Currencies

• The Bloomberg Dollar Spot Index fell 0.4%
• The euro rose 0.3% to $1.0721
• The British pound rose 0.5% to $1.2561
• The Japanese yen rose 1.4% to 156.04 per dollar

Cryptocurrencies

• Bitcoin fell 1.1% to $62,963.44
• Ether fell 3.8% to $3,184.75

Bonds

• The yield on 10-year Treasuries declined five basis points to 4.62%
• Germany’s 10-year yield declined four basis points to 2.53%
• Britain’s 10-year yield declined three basis points to 4.29%

Commodities

• West Texas Intermediate crude fell 1.4% to $82.71 a barrel
• Spot gold was little changed

This story was produced with the assistance of Bloomberg Automation.

--With assistance from Sagarika Jaisinghani and Alexandra Semenova.

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