Tech stocks rallied in after-hours trading—Nasdaq futures are up 1.2% at the time of writing, while S&P 500 futures have climbed 0.4% after the index fell 1.6% in Tuesday's session.
The first quarter 2023 results are coming in better than the last few quarters so far amid a still-healthy US jobs market, improving supply chains, cost-cutting initiatives, and a weaker dollar. But while the current earnings season may not be a negative catalyst for the equity market, the scope for upside appears limited, in our view.
Valuations are high in both absolute and relative terms. The S&P 500 forward P/E of 18x is near its highest levels in about a year, and higher than pre-pandemic levels. Historically, when the S&P 500 has traded above 18x, consensus earnings growth expectations were 14% on average, or the 10-year Treasury yield was less than 2%. Today, markets estimate S&P 500 earnings to grow 5% in the second half of this year, and the 10-year Treasury yield is 3.4%. Our own forecast is for a 5% contraction in S&P 500 earnings this year.
Recession fears are likely to cap market sentiment. Recent data continue to depict an overall weakening US economy. The US consumer confidence index slipped to a nine-month low in April, with short-term expectations deteriorating and consumers holding back on vacation and home appliance spending plans. The Philadelphia Fed’s manufacturing business outlook survey for April also fell to a new low. We expect equities to be range bound in the near term as the market oscillates between the soft-landing and recession narratives.
Lagged effects of Federal Reserve tightening should start to become more pronounced. San Francisco-based First Republic Bank earlier this week reported a near USD 102bn decline in deposits in the first quarter, while Dallas Fed President Robert Kaplan warned that smaller banks may tighten their lending to small- and medium-sized businesses. While the Fed is approaching the end of its tightening cycle, the US central bank is also unlikely to cut rates just yet. Coupled with tighter bank lending, profit growth will likely continue to come under pressure.
So, we see better risk-reward in bonds than in broad US equities in our global strategy, favoring high-quality fixed income due to decent yield and the scope for capital gains in the event of an economic slowdown. We also see value in emerging market bonds and sustainable bonds.
Main contributors - Mark Haefele, Daisy Tseng, Christopher Swann, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Tech earnings beats unlikely to propel sustainable rally, 26 April 2023.
