S&P 500 Rally Faces Test Amid Weak Profit Forecasts

Key Takeaway

• Despite 79% of S&P 500 companies beating profit expectations, weak future guidance is dampening stock performance.
• High valuations and economic uncertainties raise the stakes for corporate earnings growth, with a focus on future outlooks.
• Chipmakers' warnings and cautious consumer sector forecasts, including Starbucks' sales dip and upcoming retailer reports, signal potential market corrections.

Earnings Season Insights

The recent earnings season has shown that a strong performance in beating profit expectations may not be sufficient to sustain the stock rally. With over 400 companies in the S&P 500 Index having reported, 79% surpassed profit forecasts, yet the median stock barely outperformed the index on results day. This phenomenon, the smallest margin since late 2020, underscores the market's focus on future profitability rather than past achievements. The muted stock reactions are attributed to traders' skepticism about companies' future earnings capabilities, particularly as only 15% of S&P 500 companies issuing guidance through April exceeded estimates, marking a cautious outlook.

Guidance Takes Center Stage

The emphasis has shifted towards corporate guidance as a critical determinant of stock performance. With the S&P 500 rallying 20% from the end of October through April, valuations have stretched to 20 times projected profits, raising the stakes for future earnings growth. Keith Buchanan from GLOBALT Investments highlighted the importance of guidance in this high valuation context, especially given the backdrop of slowing US economic growth, persistent inflationary pressures, and uncertainty over interest rate cuts. The market is in search of reassurance that can only come from robust future earnings prospects.

Sector-Specific Challenges

Despite expectations for significant growth, particularly among chipmakers projected to grow around 40% in the second quarter, concerns over future profits have dampened enthusiasm. Notable examples include Intel Corp. and Advanced Micro Devices Inc., both of which saw their shares tumble after issuing disappointing forecasts. This trend of caution is not limited to the tech sector; consumer bellwethers like Starbucks Corp. have also issued weaker guidance, reflecting challenges across various industries. Investors are now keenly awaiting forecasts from major US retailers, which could further influence market sentiment.

Market Outlook and Consumer Sentiment

The broader market outlook remains tentative, with analysts pointing to the need for either a dramatic improvement in corporate guidance or a reduction in interest rates to prevent a potential correction in the S&P 500. Recent economic indicators, including a soft payrolls report and cautious commentary from consumer-focused companies, suggest a cooling labor market and slowing consumption. This environment complicates the Federal Reserve's position, as it balances an easing bias with the reality of sticky inflation. The upcoming consumer sentiment reports and retail earnings will be critical in shaping expectations for the remainder of the year.

Street Views

• Keith Buchanan, GLOBALT Investments (Neutral on the market):

  "There’s a substantive level of optimism baked in, and subsequently, considerable downside if disappointments arise... Guidance is critically important this season."

• Quincy Krosby, LPL Financial (Neutral on corporate earnings growth):

  "You have to substitute something else if you’re not going to get those rate cuts. And it had to be guidance because what else is there going to be?"

• Mike Wilson and team, Morgan Stanley (Cautiously Optimistic on consumer sectors):

  "Incrementally cautious commentary on low-end consumers in recent restaurant earnings from McDonald’s Corp. and Darden Restaurants Inc., which highlighted declines in visits from that category in their reports."

• Mona Mahajan, Edward Jones (Cautiously Optimistic on consumer-related companies):

  "We certainly remain vigilant on guidance with some of the consumer-related companies in particular, and that lower-end consumer seems to be under a bit of pressure."

• Matt Maley, Miller Tabak + Co. (Neutral/Cautious on S&P 500 outlook):

  "One of two things has to happen between now and the end of the summer: either guidance improves dramatically or interest rates come down... Otherwise, we may see another leg lower and probably a full correction in the S&P 500."