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Will Q3 earnings season halt the retreat in stocks? – Stock Markets
October 6, 2023 8:27 amVideo
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Earnings parade unofficially starts next week as stocks undergo a downside correction
A 0.1% annual earnings drop projected for the S&P 500, forecasts revised higher
Surging Treasury yields bite stocks, raging dollar an additional headwind
US indices retreat as investors face ‘higher for longer’ reality
In the third quarter, US stocks gave back some of their impressive 2023 gains as markets started bracing for a protracted period of high interest rates. As a result, US Treasury yields have been on the rise across the board, with the benchmark 10-year US yield reaching levels not seen in more than 15 years.
With yields at such high levels, negative risks for equities are increasing dangerously. Firstly, elevated yields translate into high borrowing costs that make credit more expensive for businesses. Aside from that, a higher interest rate trajectory could be devastating for stocks as the value of their projected future cash flows is recalibrated to the downside through discounting with higher rates.
Moreover, bond yields have reached a stage where they can offer a considerable risk-free income stream, allowing investors to wait until the Fed blinks. In that scenario, supposing that the Fed is forced to cut rates due to a severe recession, bondholders will not only snatch capital gains but also have the capacity to enter the stock market at more attractive levels.
Solid earnings could provide a floor
As the Q3 earnings season draws closer, we have seen an impulsive wave of upward revisions in corporate growth metrics, which started in April. Right now, the base case scenario for the US economy includes a soft landing as inflation is expected to come down without something major breaking in the economy.
Yet, according to FactSet, earnings for the S&P 500 are expected to remain stagnant on an annual basis, with forecasts suggesting just a minor 0.1% decline. However, other providers such as LSEG have a rosier view and see earnings growing by 1.6%.
From a sector perspective, Communication Services and Consumer Discretionary are anticipated to post the biggest annual earnings growth. On the contrary, only three out of the eleven sectors are forecast to report a year-on-year decline in earnings, led by the Energy sector.
Earnings could indeed surprise to the upside, given that the Atlanta Fed’s GDPNow model is projecting the US economy to grow at an annualized rate of 4.9% in the third quarter. Even if this scenario materialises, it is doubtful whether it can trigger a year-end rally considering the dire macroeconomic backdrop in Europe and China. However, better-than-expected earnings might be enough to halt the latest stock market pullback.
Not out of the woods just yet
Despite the latest positivity surrounding the corporate world’s performance, the third quarter revealed some underlying risks for the US economy. For instance, since mid-July, we have seen a massive surge in oil prices and the US dollar. The former is expected to weigh on consumer demand and reawaken inflationary pressures, while the latter is a devastating development for both the Nasdaq 100 and S&P 500 that generate a significant part of their revenue overseas.
In the US, consumer sentiment has already taken a hit by fears of a potential government shutdown and could remain under pressure until there is a final agreement on a new spending plan. Nevertheless, for a deal to be reached, Congress might have to impose material spending cuts and tax increases, which is also negative for demand.
At the same time, student loan repayments are scheduled to resume this month after a three-year break, affecting more than 28 million borrowers. These people had so far supported consumption by spending the money that would otherwise be used to repay their loans.
All in all, tight fiscal conditions coupled with quantitative tightening from the Fed could wipe excess liquidity from the markets, which in turn would negatively impact both corporate earnings and stocks’ performance.
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