Challenges and Opportunities in U.S. Corporate Earnings

Stagnation in U.S. corporate earnings is raising concerns among investors as the economy undergoes significant changes. The backdrop of rising Treasury yields and evolving market dynamics is causing experts to remain selective in their investment strategies.

Stagnant Earnings and Selective Investments

The recent report highlights that U.S. corporate earnings have failed to show significant growth in line with the broader economy. The current macroeconomic conditions, characterized by modest earnings growth and higher interest rates, do not align with the narrative of a robust economy. Experts suggest that merely focusing on earnings beating expectations might not capture the full picture, as it could mean that low expectations are merely being met.

Furthermore, the consensus outlook for S&P 500 earnings growth is around 10% over the next year, but experts advise caution, especially as about half of this expected growth is tied to mega-cap companies, where artificial intelligence (AI) plays a significant role. When these mega-cap expectations are removed from the equation, the prospects for broad equities appear muted and perhaps overly optimistic.

Sources: BlackRock Investment Institute, with data from LSEG Datastream, October 2023. Notes: The chart shows 12- month trailing earnings (solid line) rebased to 100 at the start of 2019. The dotted lines are ba

Macroeconomic Challenges and Inflation Risks

Sources: BlackRock Investment Institute, with data from LSEG Datastream as of Oct. 19, 2023.

The current macroeconomic environment is perceived as unfavorable for broad equity exposures. Rising interest rates and stagnant growth have put pressure on markets, but experts note that stocks are adjusting to this new regime. A less talked-about aspect is the stealthy stagnation witnessed in the past 18 months, marked by the weakest stretch in GDP and gross domestic income. This stagnation has largely gone unnoticed, primarily due to factors such as consumer spending, job growth, and GDP maintaining their stability.

Inflation presents another challenge, with experts predicting risks to corporate profit margins. As inflation normalizes following pandemic-induced spending imbalances between goods and services, it could impact corporate revenues, especially for firms with declining pricing power. A shrinking workforce also means that the economy’s sustainable growth rate may be lower than in the past, potentially leading to wage pressures. The risk of resurgent inflationary pressures has led to expectations of the Federal Reserve maintaining tight monetary policy, resulting in higher interest expenses for companies.

Market Valuations and Investment Strategies

U.S. stock valuations, which have driven performance during the period of earnings stagnation, remain elevated. Considering higher yields, bonds are appearing more attractive than stocks from a relative risk perspective. Experts advise maintaining an underweight position on broad equities for the next six to twelve months, while favoring sectors like technology and harnessing the power of artificial intelligence for potential earnings growth and profit margin expansion.

The technology sector has shown strength in supporting broader profit margins this year, with cash reserves acting as a cushion against higher interest expenses. Experts are closely monitoring the earnings reports of major tech firms in the coming days. They also emphasize the importance of focusing on granular sector and geographical opportunities, such as healthcare and Japanese equities.