Lofty US stocks leave investors punishing earnings disappointments

FILE PHOTO: A street sign for Wall Street is seen outside the New York Stock Exchange (NYSE) in New York City, New York, U.S., July 19, 2021. REUTERS/Andrew Kelly/File Photo

By Lewis Krauskopf

NEW YORK (Reuters) – Richly valued U.S. stocks are leaving investors with little tolerance for disappointment, raising the stakes ahead of a week in which two more technology and growth giants are set to report.

Strong reports from Microsoft and Google parent Alphabet on Thursday helped propel the S&P 500 to its biggest weekly gain since early November following its first 5% pullback of the year. The S&P 500 is up about 7% in 2024 and some 24% since late October.

But investors punished a disappointing forecast from Meta Platforms. The Facebook parent’s stock tumbled over 10% on Thursday after its report. A sales warning saw shares of industrial bellwether Caterpillar fall 7%.

More broadly, S&P 500 companies that have topped analyst earnings estimates this quarter have seen their shares outperform by a median of just 0.2%, JPMorgan strategists said. By contrast, those that have missed earnings estimates have had their shares lag by a median of 4%, the biggest such underperformance for misses in at least eight years.

Earnings reports have been “pretty good,” said Rick Meckler, partner at Cherry Lane Investments. But “anyone that’s missed in any way is paying a pretty heavy price.”

More earnings are in store in the coming week from the so-called Magnificent Seven group of companies that drove markets higher last year. Amazon reports on Tuesday and Apple on Thursday. On Wednesday, the Federal Reserve will release its latest monetary policy statement after concluding its two-day meeting.

Some believe the market’s nearly unabated run higher over the past six months has made investors less forgiving of earnings setbacks. The S&P 500 trades at 20 times forward earnings estimates, well above its historic average of 15.7, according to LSEG Datastream.

“We cautioned that potential earnings beats might not lead to equity upside during the results season, given the already strong equities run leading up to the earnings season, and stretched positioning…,” the JPMorgan strategists said. “Indeed, stock price reactions in the US (have) been underwhelming so far.”

Shares of Tesla surged 12% earlier in the week after the company said it would introduce new models by early 2025. Some investors attributed that to bargain hunting after a painful selloff this year, which left the bar for good news much lower. Tesla shares remain down over 30% for the year.

Rising Treasury yields could be another factor. Companies’ projected future profits are more heavily discounted in analysts’ models when bond yields rise, as investors can now get a higher reward from risk-free government debt. The benchmark 10-year Treasury yield hit 4.74% this week, its highest level since early November, following more evidence of stronger than expected inflation.

Overall, however, 78% of S&P 500 companies have topped analysts’ earnings estimates for the first quarter, with earnings on pace for a 5.6% rise from a year earlier, LSEG IBES said on Friday.

Solid corporate results have grown more important as climbing Treasury yields and stubborn inflation have raised uncertainty about stocks, said Chuck Carlson, chief executive officer at Horizon Investment Services.

Corporate profits are “coming through at a level that can provide support for the market and kind of overcome some of the wobbliness in the inflation and the interest rate environment here,” Carlson said.

Earnings could take a backseat if bond yields keep marching higher or inflation data remains stronger than expected. While investors do not expect any interest rate action from the Fed at next week’s meeting, they will be listening for the central bank’s insights on recent evidence of stronger than expected inflation.

Expectations for interest rate cuts, which had been a key driver of the rally, have faded following signs of economic strength and sticky inflation. Futures markets on Friday showed investors pricing in just 35 basis points in rate cuts for 2024, compared to more than 150 priced in January.

Earnings have “been a positive, but what the market’s more concerned about, I would argue, is inflation and what the Fed’s going to do about it,” said Scott Wren, senior global market strategist at Wells Fargo Investment Institute.

(This story has been corrected to say that the benchmark 10-year Treasury yield hit 4.74%, not 5.74%, this week, in paragraph 10)

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and David Gregorio)