Inflation has backed off from its highs, the economic outlook has picked up, and U.S. stocks have rallied toward fresh records, bringing Canadian stocks with them. But at least one thing stands in the way of a truly upbeat backdrop for investors: strong corporate earnings.
With 2023 now in the books, reports for the fourth quarter are on the way. Heavyweight banks such as JPMorgan Chase & Co. JPM-N, Citigroup Inc. C-N and Bank of America Corp. BAC-N will report their results on Friday.
Over the next couple of weeks, investors will get a look at everything from Microsoft Corp. MSFT-Q to Netflix Inc. NFLX-Q to Tesla Inc TSLA-Q. Their results will add to our understanding of how some of the world’s most influential companies are navigating an economy that seemed destined to slip into recession until a few months ago.
Now, though, stock prices are reflecting a far more optimistic future – a soft-landing, where inflation subsides but the U.S. economy continues to expand.
The Standard & Poor’s 500 Index has rallied 15 per cent since Oct. 27, and is now just 1 per cent below its record high two years ago.
These gains have pushed the benchmark’s price-to-earnings ratio to 22, according to Bloomberg, which is close to a two-year high. The lofty level implies that investors expect earnings will catch up with elevated stock prices.
Canadian stocks face less pressure because of lower valuations; the P/E for the S&P/TSX Composite Index is below 15. Still, the benchmark has gained 11 per cent since the end of October, and is now just 5 per cent shy of its 2022 high.
The question now is whether corporate earnings will justify the 11-week rally in stocks.
The bad news is that analysts are growing increasingly downbeat in the near-term. The consensus now expects that companies within the S&P 500 will report fourth-quarter earnings growth of 1.8 per cent, year-over-year, according to Hugo Ste-Marie, an analyst at Bank of Nova Scotia.
The change from the third quarter looks even worse, after a series of downward revisions from managers over the past few months: Earnings are expected to decline 7.9 per cent from the previous quarter, with few bright spots in the landscape.
“While poor corporate guidance is to blame, the magnitude of the adjustments suggest macro conditions also played a role,” Mr. Ste-Marie said in a note this week.
Technology is the only sector within the blue-chip index expected to report rising profits, as Microsoft, Nvidia Corp. NVDA-Q, Amazon.com Inc. AMZN-Q, Meta Platforms Inc. META-Q, Alphabet Inc. GOOGL-Q and Apple Inc. AAPL-Q power ahead.
Other sectors may be held back by an economy where the impact of high interest rates has not yet fully arrived. FedEx Corp. FDX-N, which reported its fiscal second-quarter financial results in December, offers an example of what’s at stake here.
The global package delivery company, widely viewed as a window into economic activity, reported quarterly profits that were well below analysts’ expectations and slashed its full-year revenue guidance. The share price is down 10 per cent over the past three weeks.
But the outlook isn’t entirely grim.
Ohsung Kwon and Savita Subramanian, equity and quant strategists at Bank of America, believe that a conservative outlook for profits is already baked in to share prices, offering potential for pleasant surprises if companies beat low-ball expectations.
The strategists expect that fourth-quarter profits will rise 6 per cent, year-over-year, continuing an earnings recovery that began in the third quarter. As 2024 gains steam, they expect a bullish year ahead for stocks.
“Our analyst survey into 2024 painted a goldilocks scenario for stocks,” Ms. Subramanian and Mr. Kwon said in a note.
This scenario includes higher margins, efficiency gains and easing cost pressures. Their sense ahead of the fourth-quarter reporting season is that this goldilocks scenario is “well intact.”
Investors might wish for the sort of reception that greeted the latest quarterly financial results from Aritzia Inc ATZ-T.
Though the Canadian retailer said that its profit slumped 39 per cent from last year, the adjusted per-share profit figure used by analysts easily topped estimates amid better-than-expected margins and rising revenue.
Aritzia’s share price jumped almost 21 per cent on Thursday, to $32.01 in Toronto, marking its highest level since July and offering a convincing recovery from the stock’s lows in November.
Investors can’t extrapolate a trend from this one company. But it highlights what can go right when financial results exceed low expectations. The hope for the next few weeks: More Aritzias emerge, making FedEx look like an anomaly.