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Stocks are off to a good start in the New Year. This is raising hopes among some that the worst may be behind us, while others cite various reasons to stay bearish, keeping alive questions about the market's next move. I am adding to that debate in this piece by pointing out two fundamental sources of support for the market that will help it not only stabilize, but actually rebound in the days ahead. Stocks need power to push higher, just as humans and machines do. For stocks, this 'power' comes from a variety of sources, but interest rates and corporate profits are the biggest. The market pullback last year was driven by the uncertainty among market participants about how much more the Fed will need to raise rates in its inflation fight and the impact that this extraordinarily tight monetary policy will have on the economy's health. This, in turn, blurred earnings visibility, as corporate profitability is a function of economic health. I'm leaning more towards the view that we are on the cusp of getting better clarity and visibility with respect to interest rates as well as corporate earnings. This note explains the basis for that view. I don't subscribe to the view that the recent downtrend in inflation readings has solely been the result of pullback in commodity prices, easing supply chains and some moderation in demand for the 'goods' part of the economy. This bearish view implies that the Fed will need to stay on the warpath for an extended period to make a dent in the far-stickier services part of inflation, which will push the economy into a deep recession. While recession risks have undoubtedly increased, it is hardly the only, or even the most likely, outcome for the U.S. economy. The Fed has started indicating that they are headed towards an off-ramp in the tightening cycle in which they implemented the most rapid increases in benchmark interest rates since the 1980's. This shift isn't based on wishful thinking, but rather reflective of the fact that their already-implemented tightening moves are starting to have an effect. There is little doubt now that the overall trend on the inflation front is to the downside, with each of the last 6 monthly readings showing some moderation. This doesn't mean that the Fed can declare victory, but it does mean that their hawkish stance last year has proven effective. A non-trivial part of our inflation problem was always a result of the pandemic's impact on global and local supply chains. The other part was due to the stronger-than-expected post-pandemic demand that likely got exacerbated by stimulative fiscal measures. The Fed fully understands that no amount of tightening on its part will have a bearing on stretched global supply chains. Its goal instead is to take the edge off excess demand by removing the extraordinary stimulus measures through unwinding the QE program and raising interest rates to a level where they no longer stimulate economic growth. We are close to the lower end of that range after the December rate hike. The market correctly sees the Fed implementing a 25 basis-point (bp) rate hike on February 1st, which would follow the 50 bp hike in December and the extraordinary four back-to-back 75 bp hikes preceding that. We are at the 'pivot' stage already, without the Fed explicitly telling us in so many words. After the February 1st hike, they will be 50 bps away from their indicated peak rate, meaning at most the following two meetings. The market sees these coming rate hikes as the beginning of the end for the Fed's tightening cycle and is anticipating it through pricing action ahead of time. The stock market optimism in recent days, that coincided with seemingly reassuring Q4 earnings results, is likely an early attempt to do just that. Continued . . . | ||||
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| This brings us to the second fundamental force we mentioned earlier that powers stocks higher – corporate earnings. In contrast to widespread fears of an impending earnings cliff, the ongoing Q4 earnings season is showing stability and resilience. Our unique vantage point, as one of only a handful of research teams in the country that keep a close watch over the evolving earnings trend, gives us plenty of confidence in extrapolating from what we have seen already this earnings season. The earnings picture isn't great, but it isn't even remotely as bad as market bears have been warning us of. Stepping back from the individual quarterly releases, we all know that the overall earnings growth trend has been decelerating as a result of cost pressures and moderating economic activities in response to the aforementioned Fed tightening. The way we see it, there are two aspects to the prevailing market discourse about corporate profitability that reflect a misreading of the fundamental ground reality. There is this notion that earnings estimates for 2023 are very high and remain out-of-sync with the economic outlook. This view claims that a fair earnings level for next year would be one that is below last year's level. After all, with economic growth turning negative as a result of the coming recession, earnings growth should also turn negative instead of the low-single digit positive growth currently expected. These views are widely held in the marketplace and even many well-meaning investment professionals can be seen repeating them in the financial media. However, I strongly disagree with these views and next, I'll explain why. Before I address my view that earnings estimates haven't come down enough, I would like to highlight that tracking earnings estimate revisions is a core part of our research process. It is not some tangential activity that we start paying attention to in times of macroeconomic uncertainty, but rather a fundamental driver of our equity rating system. We are always monitoring estimate revisions because that's how we rate stocks, industries and sectors. To get a nuanced understanding of trends in earnings estimate revisions, we have to appreciate that big cuts to estimates over the last many months for major sectors like Technology, Consumer Discretionary, Construction and Retail get camouflaged at the aggregate index level as a result of the unprecedented counter-cyclical behavior of the Energy sector. Regular readers know that we have consistently been pointing out that earnings estimates for the S&P 500 index outside of the Energy sector peaked in mid-April and have been coming down ever since. In fact, 2023 earnings estimates for the index are down -10.4% since mid-April 2022 as a whole, and -12.5% once we exclude the Energy sector from the index. Estimates for many key sectors like Construction, Consumer Discretionary, Retail, Technology and others are down much more sharply. The -12.5% cut to 2023 earnings estimates since mid-April is a material reset in expectations. We aren't dismissing some further downside risks to estimates, but continue to hold the strong view that a big part of the declines is now mostly behind us. Driving this view is our expectation that the coming economic downturn will be a mild and short one, unlike what we experienced in 2008. Also, keep also in mind that as we move ahead in 2023 and market participants get more comfortable with the extent of economic slowdown and the associated corporate earnings impact, they will start looking past it to the eventual recovery in 2024 and beyond. This brings us to the second point that sees the current +1.4% earnings growth expected for the S&P 500 index in 2023, as unrealistic if the U.S. economy was expected to experience two or more quarters of negative GDP growth. This seemingly reasonable assertion is comparing apples and oranges by requiring 'nominal' earnings to turn negative in the face of a modest 'real' or inflation-adjusted decline in GDP. The fact is that U.S. GDP growth will most likely remain positive in nominal terms in our outlook of a mild and short-lived recession. We strongly believe that investors will find it difficult to justify continued market weakness in the face of stable and resilient earnings releases in the days ahead, particularly as they gain more confidence in their Fed outlook. The market set up for this earnings season couldn't have been better. Putting It All Together The ongoing Q4 earnings season is far from confirming the doom-and-gloom fears of market bears. Granted earnings aren't great, but no one expected that at this stage of the cycle in the face of aggressive Fed tightening. Importantly, they are as good as could be expected in this environment. What we are seeing instead is continued resilience in household and business spending, with tell-tale signs of the expected moderation. This implies an orderly slowdown instead of falling off the cliff. The implication of all of this discussion of interest rates and earnings for investors is that while we still have to contend with some uncertainties, the clouds have started to lift. We typically know of market bottoms only in retrospect and this time will likely be no different. But we are reasonably confident that the worst is now behind us. How to Take Advantage Today is an ideal time to get aboard this market. That's why I'm inviting you to download our just-released Special Report, 5 Stocks Set to Double. Each of the following stocks was handpicked by a Zacks expert as their personal favorite to have the best chance of gaining +100% and more in the months ahead: Stock #1: An innovative manufacturer of x-ray and medical imaging applications Stock #2: An international provider of cutting edge software and robotic solutions Stock #3: A global 50-year-old top producer of highly sought after metal products Stock #4: A multi-segmented financial services company embracing groundbreaking technology Stock #5: A leading tech company providing network solutions in Europe, the Americas, Asia, and more The earlier you get into these new stocks the higher their profit potential. Previous editions of this report have racked up some huge gains. Examples include Boston Beer Co. +143.0%, NVIDIA +175.9%, Weight Watchers +498.3% and Tesla +673.0%.¹ To put the odds of success even more in your favor, you are also invited to look into our unique arrangement called Zacks Investor Collection. It gives you access to the picks and commentary from all our long-term portfolios in real time for the next 30 days. Plus, it includes Zacks Premium research so you can find winning stocks, ETFs and mutual funds on your own. Last year alone, they closed 42 double and triple-digit wins. Gains reached as high as +188.3%, +348.7%, and even a remarkable +995.2%.¹ The opportunity to download this just-released Special Report, 5 Stocks Set to Double, ends Sunday, January 29. Get started now with Zacks Investor Collection and 5 Stocks Set to Double » All the Best,
Sheraz Mian serves as the Director of Research and manages the entire research department. He also manages the Zacks Focus List and Zacks Top 10 Stocks portfolios. He invites you to access Zacks Investor Collection | ||||
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| ¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position. This free resource is being sent by Zacks.com. We look for investment resources and inform you of these resources, which you may choose to use in making your own investment decisions. Zacks is providing information on this resource to you subject to the Zacks "Terms of Service". https://www.zacks.com/terms_of_service Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research is not a licensed securities dealer, broker or US investment adviser or investment bank. The Zacks #1 Rank Performance covers the period beginning on January 1, 1988 through January 2, 2023. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank #1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performance_disclosure for information about the performance numbers displayed above. Zacks Emails Zacks Investment Research |
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