‘Priced for perfection’ stocks stay in tight range
The stock market kicked off the week on a cautious note, with traders sifting through remarks from a slew of Federal Reserve speakers while awaiting key inflation data and the start of the earnings season.
Following a three-day slide in the S&P 500, the benchmark posted a small gain. The market didn’t get much support from the megacap space as Tesla fell almost 2% and Amazon.com dropped before its Prime Day event. The Nasdaq 100, which notched a historic first half of a year amid the artificial-intelligence craze, will go through a “special rebalance.” A gauge of big banks pared gains on news about a plan to boost capital requirements.
In the run-up to Wednesday’s consumer price index, the market got the latest thinking from a raft of policymakers. Three Fed officials – Michael Barr, Mary Daly and Loretta Mester – said the central bank will need to raise interest rates further this year to bring inflation back to its 2% goal. Meantime, Fed Bank of Atlanta President Raphael Bostic noted officials can be patient amid evidence of an economic slowdown.
Market momentum has slowed since equities notched a strong first-half rally as concern resurfaced about the impact of the many economic crosscurrents on corporate profits. Morgan Stanley’s Michael Wilson became the latest to warn that earnings forecasts will matter more than usual this time around given elevated equity valuations, higher interest rates and dwindling liquidity.
“Many risks still lie ahead,” said Seema Shah, chief global strategist at Principal Asset Management. “With broad equity valuations having once again become stretched and market breadth extremely narrow, the market is priced for perfection - leaving it vulnerable to earnings disappointments.”
- - -
This is the fifth straight time that analysts are leaning bearish heading into the earnings season, and in each of the four prior periods, the news wasn’t nearly as bad as expected - spurring an average gain of over 6% for the S&P 500, according to Bespoke Investment Group.
“Will this earnings season finally be the quarter that proves analysts correct?” the firm’s strategists said in a note. “If they stay negative every quarter, eventually they’ll be proven right, but betting against the market heading into earnings season recently proved to be an expensive ride.”
The earnings season kicks off in earnest on Friday, when JPMorgan Chase, Citigroup and Wells Fargo report their numbers. There’s more pain on the way for the S&P 500 as profit warnings and fears of higher interest rates combine to threaten the key U.S. stock indicator, according to the latest Markets Live Pulse survey.
While earnings seasons have usually been positive for equities in the past decade, according to Deutsche Bank strategists, the upcoming one will hurt stocks, said 55% of the 346 MLIV respondents.
To Matt Maley at Miller Tabak, it’s going to be harder for the market to rally if the earnings season is “not as bad as we thought” - especially since the market has become so expensive.
This does not mean that if the guidance from companies is “just OK,” the market will sell off meaningfully, Maley added. However, if corporate outlooks show any material disappointment, “it should create some serious headwinds for the stock market.”
The question is whether earnings can continue to bend without markets breaking, according to Saira Malik at Nuveen. With analysts cutting earnings estimates in recent weeks, companies may once again find it easier to deliver stronger-than-expected results.
“We are cautious about the self-fulfilling optimism driven by these diminished expectations,” Malik noted. “Additionally, we’re mindful of mixed U.S. economic data and the potential for two more rate hikes this year.”
In other corporate news, a gauge of U.S.-listed Chinese shares climbed on news the Asian nation will extend policies to support the property market. Icahn Enterprises soared as Carl Icahn renegotiated loan terms with a group of banks just months after a report by Hindenburg Research sent shares in his investment firm tanking. Cava Group rallied as a majority of brokers initiated coverage on the fast-casual restaurant operator with buy-equivalent recommendations.