A warning sign for U.S. stocks? Institutions sharply lower their profit forecasts, and the test of the earnings season is coming

After last year’s third-quarter earnings season, U.S. stocks ended a nine-month “earnings recession.” As the Federal Reserve is about to cut interest rates and anticipate soft landings, the market has become increasingly optimistic about the earnings prospects of listed companies in 2024, and valuation levels are also rising. However, facing the pressure of economic slowdown, institutions are continuously lowering their performance outlook for the last quarter, and many industry giants have also recently issued performance warnings. Investors will pay attention to the banking industry's economic outlook. Whether technology giants that have performed well in the past year can continue their strength will also be a major focus.

Economic slowdown weighs on performance rebound

Forecasts from Datastream, a data platform owned by the London Stock Exchange (LSEG), show that earnings of S&P 500 index constituents are expected to grow by 11.1% in 2024. The index currently trades at 19.8 times forward 12-month expected earnings, significantly higher than the long-term average of 15.6 times.

The Wells Fargo Investment Research Institute recently released a report stating that the market's trading levels reflect investors' huge confidence in the economic outlook, especially after the Federal Reserve considers turning to interest rate cuts. However, potential risks include an economic slowdown and the continued impact of high interest rates on corporate earnings.

In fact, the impact of the economic cooling will be felt from the upcoming earnings season. The Atlanta Fed's GDP model shows that U.S. economic growth will slow to 2.8% in the fourth quarter of last year from the previous 4%. According to statistics from FactSet, institutions have been gradually lowering their profit forecasts since October last year. They have been revised down by a cumulative 6.8%, a new high in the past five quarters and higher than the average level in the past 10 years.

In terms of industries, among the 11 industries, only public utilities (+1.9%) and information technology (+1.7%) are the only two sectors whose performance has been revised upward. The expected earnings of the other industries have all declined, among which healthcare (- 21.3%) and materials (-13.5%) industries were among the top decliners.

S&P industry performance expectations have generally been revised downwards (Source: FactSet)

Changes in consumer habits behind the cooling economy have also had an impact on many industries. Nike said it plans to cut up to $2 billion in costs over the next three years, including reducing management, as more expensive necessities such as groceries continue to deter customers from buying sneakers and athletic gear. Electronics retailer Best Buy Co. has lowered its annual sales forecast and has been discounting items such as clothing and electronics. FedEx said customers are switching to cheaper shipping options while demand remains weak.

As usual, banking stocks will be the first to release performance reports. In addition to the continued downturn in IPOs, consumer credit, bad debts and trading business performance will become areas of concern to the market. At the same time, the outside world will also pay attention to financial institutions' views on the industry and economic prospects. After the bankruptcy of regional banks last year, their judgment on the prospects and impact of the Federal Reserve's policies will become a major focus.

Can technology stocks stay strong?

Last year, technology stocks became the biggest focus of the market. The "Big Seven" consisting of Apple, Microsoft, Google parent company Alphabet, Amazon, Nvidia, Facebook parent company Meta and Tesla contributed nearly 70% of the S&P 500 index's annual increase. %.

Performance has become the key for technology giants to significantly outperform the market. According to LSEG data, the earnings of the seven companies increased by an average of 39.5%, while the remaining 493 companies in the S&P 500 saw earnings decline by 2.6%.

Optimism about the prospects of artificial intelligence may continue to attract investors. As the 2024 International Consumer Electronics Show (CES) opens in Las Vegas, the United States, this week, chip giant Nvidia, which has released a number of blockbuster new products, once again set a new record high, with a market value approaching US$1.3 trillion.

Boris Schlossberg, macro strategist at BK asset management, said in an interview with China Business News that it can be seen from the Bank of America fund manager survey that technology stocks have once again become the most crowded trade. In fact, shares of these tech giants are widely held by mutual funds and ETFs and could benefit from further inflows from the sidelines. In addition to the broad industry prospects, the Fed's interest rate cuts will also benefit the resilience of its market capitalization. "Under the influence of the fear of missing out (FOMO), the larger the market value, the more optimistic people may be."

Currently, the forward price-to-earnings ratio of the seven technology giants mentioned above has reached 33.6 times, while the overall S&P 500 index is 19.8 times. Schlossberg believes that compared with last year, the gains of these technology leaders may have some twists and turns, and they will not continue to significantly outperform the market. Because the valuation level needs to be digested, and at the same time, the gradual recovery of other industries will also narrow the performance gap.

Tom Lee, a representative of U.S. stock bulls and head of research at Fundstrat, said that while being optimistic about technology stocks, investors need to guard against the following risks. The first is the Federal Reserve. Although the market expects an interest rate cut in March, the Federal Reserve seems unsure when it will begin to relax. The delay in the policy turning point will affect the current valuation level. Secondly, there is industry regulation. The rapid development of artificial intelligence technology has attracted the attention of governments around the world. Restrictive measures may delay the release schedule of corporate performance.