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U.S. fourth-quarter corporate earnings season is in full swing. We don’t see it spoiling upbeat risk appetite for now. The S&P 500 hit an all-time high recently as most top tech firms beat high earnings expectations. Yet we think earnings will recover less than markets expect this year after stagnating in 2023. Tech gains and cost cutting have buoyed margins, but we see pressures mounting over time. We’re overall overweight U.S. stocks as we think rosy market sentiment can persist for now.
We’re in a new regime of greater macro and market volatility, and that’s reflected in corporate profit margins. S&P 500 net profit margins expanded to all-time highs during the pandemic as firms passed on higher costs to consumers. The reversal of pandemic spending patterns and solid wage growth have pushed margins down from a peak of roughly 13% (green line in the chart). Still, margins have held up better than we expected against these pressures and higher interest rates.
We think a handful of mega-cap tech firms – those with ultra-large market capitalizations – have buoyed margins. Stripping out mega-cap tech, S&P 500 profit margins have normalized closer to pre-Covid levels (yellow line). Cost-cutting measures such as layoffs have helped companies preserve profit margins for now. We think margins have room to fall further once cost cutting ends and inflation resurges.
Mega cap tech stocks have rallied since last year over excitement about artificial intelligence (AI). Digital disruption and AI is one mega force, or structural shift, we seeing playing out over years and being a key earnings driver. Our work finds a positive correlation between a rise in AI patents and earnings growth in the one-to-two years after the patent registration. Analysts expect mega-cap tech earnings to grow 21% this year – a third of S&P 500 earnings growth, LSEG data show. That’s a high bar, in our view. So far, most mega-cap tech names have beat lofty fourth-quarter expectations.
Meanwhile, analysts expect broader earnings to grow about 11% this year, in line with expectations for S&P 500 margins to rebound toward 13% in the next 12 months, LSEG data show. That earnings growth would be an improvement from stagnation, with earnings on track to have grown just 1% in 2023. We expect earnings to land just below consensus this year. And while we think margins could tick up, analyst estimates look too optimistic. We see cost pressures on margins mounting as the year progresses. Yet tech delivering on earnings and further cost-cutting measures could alleviate pressures for now.
Ultimately, we think market sentiment on stocks is anchored on the outlook for policy rates and inflation. Stocks rebounded quickly from mixed tech earnings earlier this month and after Fed Chair Jerome Powell ruled out a rate cut as soon as March. The Fed is watching for inflation to fall sustainability to 2%.
We’ve said before that we think goods inflation will push inflation near 2% this year. What matters is we think the Fed will start to cut rates as that scenario plays out. Yet we believe the rally will be upset by resurgent inflation coming into view later this year and margins facing pressure. Still-high wage growth is one key factor that will put inflation on a rollercoaster toward 3% in 2025, in our view. That will likely renew cost pressures on companies. We watch for wages growing faster than the prices received by good producers to gauge margin pressures.
We’re overweight overall U.S. equities, including the AI theme, on a tactical horizon of six to 12 months. That’s because we think the rosy market sentiment has room to run for now. Earnings and margins won’t spoil the mood yet, in our view. We’re neutral U.S. stocks on a strategic horizon as we expect high-for-longer interest rates to weigh on valuations.
Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.
Wei Li, Global Chief Investment Strategist – BlackRock Investment Institute, Natalie Gill Portfolio Strategist – BlackRock Investment Institute, and Carolina Martinez Arevalo, Portfolio Strategist – BlackRock Investment Institute, contributed to this article.
Disclaimer
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
© 2024 BlackRock Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. This article first appeared Feb. 5, 2024, on the BlackRock website. Used with permission.
Image: iStock.com/udra
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