Stocks Are Trading at Records—Strong Earnings Could Send Them Even Higher
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A week into first-quarter earnings season, S&P 500 companies are handily beating expectations, suggesting corporate profits remain resilient in the face of geopolitical and economic uncertainty.
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The market’s reaction to earnings has been muted thus far, according to a Bank of America analysis, but some experts see pockets of opportunity in sectors, like tech, where the Iran war has compressed multiples while earnings are growing.
Wall Street was expecting a lot of first-quarter earnings. A week in, it’s going even better than expected.
The share of S&P 500 companies topping expectations and the magnitude of their beats are both ahead of long-term averages, according to FactSet Research. Nearly 90% of companies have surpassed expectations, compared with an average of 76% over the past decade. In aggregate, earnings have exceeded estimates by nearly 11%, well ahead of the 10-year average of 7%.
AI investment made technology earnings especially strong. The S&P 500 tech companies that have reported so far grew earnings by 45%, more than twice the pace of the next-best sector. Results outside the U.S. also contributed to a bullish outlook. Taiwan Semiconductor Manufacturing Co. (TSM) reported “extremely robust” AI chip demand, which was also visible in chip manufacturing equipment firm ASML’s (ASML) better-than-expected results.
Investors were expecting a strong first-quarter earnings season, but the war in Iran has generated a cloud of uncertainty that’s loomed over markets since early last month. Broadly better-than-expected results suggest the economy may withstand war shocks and other risks more easily than Wall Street thought.
Analysts have increased their estimates for tech sector earnings by about 5% since the end of January, more than any sector other than energy, which is expected to get a boost from higher oil prices, according to a recent BCA Research report. Though a few semiconductor makers account for the bulk of the increase, “gains remain broad-based, with 80% of Tech stocks seeing positive revisions over the last three months,” according to BCA.
Rising earnings expectations are being fueled by Big Tech’s growing investments in artificial intelligence. Analysts have increased their forecasts for capital expenditures at the five major hyperscalers—Alphabet (GOOG), Microsoft (MSFT), Amazon (AMZN), Meta (META) and Oracle (ORCL)—by 25% since the start of the year, according to Bank of America. The tech giants are now expected to invest $680 billion this year, up 63% from last year.
While earnings are strong, the stock market reaction has been less than stellar, according to Bank of America. Companies that beat top-and bottom-line expectations performed about as well the broader market last week. Historically, stocks outperform the market by about 1.4 percentage points after posting a double beat.
“It’s early, but muted reactions to beats suggests that solid 1Q results alone are insufficient, that big moves on geopolitics have subsumed earnings results, and guidance is more important,” wrote Savita Subramanian, BofA’s head of U.S. equity and quantitative strategy.
Granted, last week’s earnings landed amid surging optimism that an end to the war in Iran, and the largest oil supply shock in history, may be in sight. The S&P 500 closed at a record high for the third consecutive day on Friday, while the Nasdaq posted its longest winning streak since 1992. While stocks retreated slightly on Monday, their sharp rebound off of recent lows could set a high bar for companies to clear in the coming weeks.
Though experts still see pockets of opportunity, especially in tech, where stocks are “on sale.” The tech sector’s PEG ratio—a forward-looking valuation metric—is currently the lowest of all sectors “and sits in the bottom quartile of its own history,” according to BCA analysts.
Software stocks, beaten down this year by concerns about AI-driven disruption, are particularly attractive heading into earnings, BCA says. “Clarity from management that AI adoption is a revenue tailwind, not an existential threat, could help tamp down investor fears,” the analysts argue. The industry’s low stock valuations and strong earnings growth add to their conviction. “Trough multiples for accelerating earnings are too good to pass up,” the analysts wrote.
ServiceNow (NOW) will kick off software earnings when it reports on Wednesday. Other big tech names reporting this week include Tesla (TSLA), Lam Research Corp. (LRCX), IBM (IBM), and Intel (INTC). Other big-name companies slated to report are UnitedHealth Group (UNH), GE Aerospace (GE), Boeing (BA) and American Express (AXP).
Ninety S&P 500 companies representing about 14% of the index’s earnings are slated to report this week. The season peaks next week when companies accounting for more than 40% of S&P 500 earnings are scheduled to report.
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