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Earnings season is winding down, and a strange confluence of events is occurring – the economy is softening, but corporate profits are accelerating.
Some analysts think that means good news for stocks in the second half of the year.
What's happening: Last week proved that investors are on edge and scrambling for clues about what comes next – even relatively insignificant economic indicators are capturing outsized attention on Wall Street.
The Dow plunged by more than 600 points, notching its worst day of the year so far, on Thursday after the Purchasing Managers Index for May, expected to fall slightly, came in 3.5 percentage points higher month-over-month. That, in turn, suggested to investors that the Federal Reserve won't be cutting interest rates anytime soon, sparking the selloff.
PMIs provide early insights into the economic health of the manufacturing and services sectors by surveying purchasing managers on their business conditions. It's a useful tool, but doesn't typically get a lot of attention on Wall Street.
Other data, like Institute for Supply Management reports, are generally considered more comprehensive and influential.
Last weeks wild reaction to the PMI highlights the market's current sensitivity to economic data as investors fret over Fed interest rate decisions. Even secondary economic indicators are shaping market sentiment and influencing investment decisions as Wall Street worries that a more robust economic environment can mean higher-for-longer interest rates.
Yes, but: There's an interesting dynamic at play as investors worry about corporate profits and a stronger economy at the same time, wrote Bank of America analysts in a client note on Tuesday.
Higher interest rates can increase borrowing costs and reduce corporate profits, leading to a sell-off in equities as investors adjust their expectations for future growth and profitability – that's where the worry comes from. But that hasn't really happened. At least not yet.
About 97% of S&P 500 companies have reported their first quarter earnings at this point. And so far, they've beat consensus earnings-per-share estimates by about 3%, according to Bank of America. Earnings are up by 7% since this time last year, and all 11 S&P 500 sectors, with the exception of healthcare, beat estimates.
There were some concerns about companies lowering their outlook for the rest of the year, but, overall, estimates for the remainder of 2024 have slightly risen this quarter.
"The equity cycle feels different than the macro cycle today. While [gross domestic product] and the labor market seem to be slowing, earnings are accelerating," wrote the Bank of America analysts.
Historically, a slowing economy and accelerating earnings backdrop has been the best environment for stocks, they wrote. This could point to a strong second half of the year for markets.
Yes, but, but: That also means that there could be a lot of sensitivity and extreme market swings when economic data comes in stronger than expected, which we saw last week.
Still, the Fed is only part of the equation. Goods and manufacturing represent about half of earnings for the S&P 500, the BofA analysts wrote. But they make up less than 20% of the US economy.
That means an improving manufacturing cycle but slowing services can lead to a divergence between market performance and economic performance.
Coming up next: All eyes, meanwhile, are on the release of the US Personal Consumption Expenditures index for April on Friday – that's the Fed's preferred inflation gauge. There are also some notable earnings reports coming in this week – including Salesforce, Dell and Marvell. In consumer sectors, the list includes Dollar General and Costco.
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