Current rally unsustainable as earnings weaken

  • The current stock market rally from the low of mid-June is unsustainable, according to BlackRock.
  • The asset manager told clients that the rally in equities would be derailed by deteriorating earnings and more Fed rate hikes.
  • “We see the Fed raising interest rates to levels that will slow the economic restart,” BlackRock said.

BlackRock sticks to its recommendation for investors to be underweight equities, calling the current rally unsustainable due to deteriorating corporate earnings and ongoing rate hikes by the Federal Reserve.

The S&P 500 is up about 18% from its mid-June low, while the Nasdaq 100 is up more than 20% as inflation showed signs of cooling and the Fed signaled that future rate hikes could be smaller than recent increases of 75 basis points.

But investors should not be too hopeful that the worst of the stock market decline is over, according to BlackRock.

“Stocks jumped on hopes that the Fed would pause rate hikes once inflation goes down. We think that’s premature and see inflation stabilizing above pre-Covid levels,” BlackRock said.

If inflation remains high, more Fed rate hikes are likely. In addition, corporate profits could sharpen as consumers shift spending from goods to services.

“We see the Fed raising interest rates to levels that will slow the economic restart. Corporate profits could weaken further as consumer spending shifts and profit margins shrink,” BlackRock said.

Second quarter earnings have proved resilient, but the current composition of the economy relative to the stock market means earnings results could weigh on stock prices going forward, BlackRock said.

That’s because consumer spending is shifting from goods to services, and the S&P 500’s revenue is mostly made up of goods companies.

Revenues linked to goods are expected to make up 62% of S&P 500 earnings this year, versus 38% linked to services. In addition, the stock market is not the economy. Goods accounted for less than a third of the US economy in the first half of this year, meaning a boom in services is not boosting S&P 500 earnings as much as the economy is,” explains BlackRock.

Meanwhile, overall spending could fall as BlackRock believes economic activity in the US will contract as the country evades production and labor restrictions.

Ultimately, BlackRock calculated that the S&P 500’s earnings growth “has come to a halt” when the energy and financial sectors are excluded, down from the quarter’s 4% annualized growth rate.

“We’re not chasing the rally. Why? First, market expectations for a dovish [Fed] game are premature. We think a pivot will come later as the Fed is reacting to inflationary pressures for the time being. Second, we think the market’s view of earnings is too optimistic,” concludes BlackRock.

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