Souring Profit Outlooks Threaten S&P 500’s 20% Rally

(Bloomberg) — Strong earnings beats from Corporate America may no longer be enough to keep the stock rally going. Profit outlooks are becoming more important.

With more than 400 firms in the S&P 500 Index having reported earnings this season, 79% of them have beaten profit expectations, according to data compiled by Bloomberg Intelligence. But the median stock outperformed the index by less than 0.1% on results day — the smallest margin since late 2020.

The muted reaction can be explained by one thing. Traders, unconvinced that companies can deliver going forward, are punishing stocks for weaker-than-expected guidance.

Among the S&P 500 companies that issued guidance through April, 15% provided an outlook that exceeded estimates, the second-lowest reading since the pandemic, according to Bloomberg Intelligence data. There was a slight uptick in the latest week, with firms such as Apple Inc. giving forecasts that topped estimates, helping to push the percentage to 18% — still low compared to history.

Muted Outlook | Through April, 15% of S&P 500 companies gave guidance that topped estimates

A 20% rally in the S&P 500 since the end of October through April had pushed the equity gauge to trade at 20 times projected profits, some 11% above its 10-year average. Traders are now looking for reasons to justify the high valuations and want to see bigger growth ahead.

“There’s a substantive level of optimism baked in, and subsequently, considerable downside if disappointments arise,” said Keith Buchanan, senior portfolio manager at GLOBALT Investments. “Guidance is critically important this season,” given high valuations, he added.

With US economic growth falling to an almost two-year low last quarter, inflationary pressures lingering and uncertainty over interest rate cuts, the bar has been raised for corporate earnings growth.

“You have to substitute something else if you’re not going to get those rate cuts,” said Quincy Krosby, chief global strategist at LPL Financial. “And it had to be guidance because what else is there going to be?”

Across the S&P 500, chipmakers are expected to grow roughly 40% in the second quarter, which would be the strongest rate among all industry groups, according to Bloomberg Intelligence. But even that wasn’t enough to keep the Nasdaq 100 Index trading above its pre-earnings season level as some of the biggest chipmakers warned about future profits.

Intel Corp. shares tumbled after the biggest maker of personal computer processors issued a weaker than anticipated second-quarter outlook. Advanced Micro Devices Inc. shares also fell after the firm issued a disappointing forecast for its artificial intelligence processors.

S&P 500 Earnings Tracker | Share of members that beat, missed or matched analyst EPS expectations

As for other industries, results from consumer bellwethers are still weeks away. But Morgan Stanley strategists led by Mike Wilson have cited 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.

Starbucks Corp. said sales fell for the first time since 2020 as transactions declined in every region over the quarter and the company cut its full-year revenue growth forecast to low single-digits.

“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,” said Mona Mahajan, senior investment strategist at Edward Jones.

Investors will be bracing for forecasts from the biggest US retailers, most notably Walmart Inc. and Target Corp., when they report results later this month as well as the latest read on consumer sentiment next week.

“One of two things has to happen between now and the end of the summer: either guidance improves dramatically or interest rates come down,” said Matt Maley, chief market strategist at Miller Tabak + Co. “Otherwise, we may see another leg lower and probably a full correction in the S&P 500.”

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