The valuation of the U.S. stock market has reached its peak in approximately two years, raising questions about its sustainability as companies begin to release their earnings reports in the coming weeks.
With a 9% increase year-to-date, the S&P 500 (SPX, Financial) has seen its strongest start since 2019. However, this growth sets a high benchmark, demanding robust earnings from companies to maintain the momentum.
The S&P 500 is currently trading at 20.7 times its forecasted earnings for the next year, closely approaching its two-year peak. This situation suggests that without significant earnings growth, investors might pivot towards bonds, attracted by their high yields.
Investors are also keenly awaiting insights on economic and inflation outlooks from companies, aiming to determine if the favorable scenario of steady growth and easing inflation can persist.
Recent data showing persistent inflation has tempered expectations for Federal Reserve rate cuts this year, even as stocks gained following a surprisingly strong employment report.
"Achieving further stock market gains hinges not just on meeting but exceeding earnings forecasts," Yung-Yu Ma of BMO Wealth Management noted.
Companies like Delta Air Lines (DAL, Financial), BlackRock (BLK, Financial), and JPMorgan Chase & Co (JPM, Financial) are poised to announce their first-quarter earnings soon, with the market also anticipating the March U.S. consumer price index on April 10.
Earnings growth is anticipated to be around 5% for the first quarter, marking the lowest since the second quarter of 2023, pressured by high interest rates and rising costs.
The performance of leading companies such as Nvidia (NVDA, Financial), Meta Platforms (META, Financial), and Microsoft (MSFT, Financial) will be crucial for market sentiment, especially after the varied performance of key tech stocks last year.
Nvidia has surged 78% in 2024, while Tesla (TSLA, Financial) has seen a significant drop due to concerns over its profitability and demand. The cancellation of a much-anticipated budget car model has further impacted Tesla's outlook.
"These companies must now validate their high valuations," stated Bryant VanCronkhite from Allspring Global Investments, emphasizing the importance of clear future demand indications.
Moreover, the resilience of the U.S. economy could bolster revenues and earnings across various sectors, with energy and industrial companies particularly benefiting from this year's broader market rally.
"Exposure to sectors tied to the real economy is advisable if the U.S. economy rebounds," Justin Menne from Harbor Capital Advisors mentioned, highlighting a preference for energy stocks.
Liz Ann Sonders from Charles Schwab warned of potential repercussions for companies falling short of expectations, with a focus on their profit margins.
The Federal Reserve's decisions will be a key consideration for investors, as strong earnings and inflation concerns could suggest the economy is too robust for rate cuts without risking inflation.
The March employment report, showing a significant job increase, supports this view, with futures markets now expecting less aggressive rate cuts from the Fed compared to earlier predictions.
Conversely, weaker earnings could reveal economic vulnerabilities, potentially advocating for Fed intervention through monetary policy easing, according to Kevin Mahn of Hennion & Walsh Asset Management.
