Global equity markets have maintained their strong start to the year, despite investors needing to recalibrate their expectations for the timing of interest rate cuts. Recent global economic data has been mixed, whereas in the U.S. it has largely exceeded expectations, with the latest inflation reading suggesting a modest uptick in price pressures. Meanwhile, minutes from the U.S. central bank’s recent meeting revealed that policymakers continue to ponder the risks associated with premature rate reductions. Below, we discuss the earnings season, which is now in its final stages.
A key factor behind the equity market's strength lately has been earnings results. Fourth quarter U.S. earnings are set to rise by just over 3% year-over-year, roughly double the expected pace. Though not remarkable in absolute terms, this growth is notable given the anticipated drag from higher interest rates on operating profits. Earnings results were especially strong across some pockets of the Consumer, Industrials, and Technology sectors. The “Magnificent Seven” technology-centric stocks, which make up nearly 30% of the U.S. S&P 500 index, have been crucial to driving the market’s overall earnings growth due to their sheer size and influence. Without their contribution, earnings growth would have declined by 4% year-over-year. In other words, while the U.S. market’s earnings growth looked fine relative to expectations, the strength of its underlying companies may be overstated given the lack of breadth.
During this earnings season, comments from management teams have been generally positive with respect to consumer demand, although several noted consumers’ growing sensitivity to prices. Nevertheless, many companies highlighted robust economic indicators, such as high job creation and low unemployment claims. In their view, this suggests consumers can continue to spend, albeit with budgets strained by inflation. And while retail sales numbers recently came in below expectations, they remain significantly higher than pre-pandemic levels. Management perspectives varied on operating conditions, with some looking for clearer guidance on interest rates and others voicing concerns over persistent inflationary pressures and cost challenges. Across the board, there was a clear focus on cost management and profit margin improvement.
As we look to the rest of 2024, earnings growth is expected to pick up. Analyst estimates suggest an earnings growth rate of nearly 9% for the year. And unlike the past year, this growth is anticipated to be more broadly distributed across various companies, not just the “Magnificent Seven”. This more evenly distributed earnings growth would be a welcome development, but this outlook is predicated on several assumptions: consumer and business demand that remain resilient and potentially improve, a deceleration in inflation, and lower interest rates. While such a scenario is entirely possible, the range of potential near-term outcomes remains wide, given how far interest rates have moved over the past few years and questions regarding inflation’s future trajectory. In managing portfolios, we are displaying greater caution than usual, given these uncertainties.
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