Higher bar for US earnings to deliver
Market take
Weekly video_20240422
Beata Harasim
Opening frame: What’s driving markets? Market take
Camera frame
We saw 2024 as a year of two stories: First, cooling inflation and strong earnings would support upbeat risk appetite.
Next, inflation would rollercoaster back up and disrupt sentiment.
Title slide: Higher bar for US earnings to deliver
Recent inflation data suggest inflation isn’t cooling as quickly as we expected, implying that the second phase may be happening now.
We think that raises the stakes for first quarter US corporate earnings to support sentiment.
1: Inflation and interest rates
With heightened tensions in the Middle East, oil and commodity prices could be high for longer, reinforcing the new regime of hotter inflation and higher-for-longer interest rates.
Corporate earnings
Markets have cut their expectations for rate cuts in line with our view, and US stocks have started to slid.
We question if that is a blip or a shift toward pricing in inflation and interest rates settling above the pre-pandemic levels.
We think tech companies have to deliver on high earnings expectations and other sectors have to post better results to sustain risk appetite.
3: Exploring the AI theme
We still prefer artificial intelligence (AI) beneficiaries.
We are eyeing [the] next wave of AI winners further up the technology stack.
We see AI adoption broadening into the healthcare, financials and communication services sectors where we see more room for productivity gains coming soon.
Outro: Here’s our Market take
We’re overweight US stocks yet stay ready to pivot. We get selective in sectors favoring the AI theme.
Closing frame: Read details:
www.blackrock.com/weekly-commentary.
US stocks have slid from their highs as inflation proves sticky and geopolitical tensions rise. We eye whether corporate earnings can keep buoying sentiment.
The S&P 500 slid 3% last week on jitters before key tech earnings results and rising bond yields. Geopolitical flare-ups are keeping oil prices elevated.
We look to this week’s US PCE release for any signs of acceleration or stubborn services inflation. We see inflation and interest rates staying higher for longer.
We saw 2024 as a year of two stories. First, cooling inflation and solid corporate earnings would support upbeat risk appetite. And later, resurgent inflation would come into view and disrupt sentiment. We stay overweight US stocks yet are ready to pivot. The second leg may be playing out now, reinforcing our expectations for persistently high inflation. That raises the stakes for Q1 corporate earnings to buoy sentiment, in our view, just as higher bond yields add pressure to equity valuations.
Baking in higher-for-longer rates
S&P 500 valuations and interest rate expectations, 2021-2024
Forward looking estimates may not come to pass. Index returns do not account for fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from LSEG Datastream and Bloomberg, April 2024. Notes: The chart shows the forward price-to-earnings ratio for the S&P 500 and the market pricing of the fed funds rate in three years, based on SOFR futures.
We’ve expected inflation would be on a rollercoaster as the drag from falling goods prices faded and firm wage growth made services inflation stubborn. Yet the March pick-up in core services inflation shows that inflation is proving sticky. Further escalation of Middle East tensions could see oil prices staying elevated, reinforcing higher inflation and higher-for-longer interest rates. Sticky inflation has prompted markets to slash their expectations for Federal Reserve rate cuts to less than two this year (green line in chart) in line with our view. The Fed has gone from blessing market hopes for inflation to fall to 2% without a growth hit to implying policy may have to stay tight. The S&P 500 price-to-earnings ratio – a popular valuation metric – shows stocks feeling the heat from higher rates (orange line). We think that’s why it’s more crucial that companies keep meeting or beating high earnings forecasts.
We question whether the slide in stocks is a blip or a bigger shift toward pricing in inflation – and interest rates – settling higher than pre-pandemic. We stay overweight US stocks on a six- to 12-month tactical horizon but are ready to pivot given that uncertainty. We have broadened out our stock view to include segments of the market with an improving earnings growth outlook. And we have leaned against small cap stocks whose earnings are at greater risk from higher rates. Earnings face a critical test this week, with some mega cap tech companies reporting. With stocks under pressure and rate cut hopes fading, we think the bar is higher for tech firms to deliver on earnings expectations – and for other sectors to show an earnings recovery. Confirmation of inflation settling higher and earnings misses could trigger a change to our view.
Moving up the tech stack
We still prefer artificial intelligence (AI) beneficiaries to tap into the AI and digital disruption mega force – a structural shift driving returns now and in the future. We went overweight early AI winners and enablers like chip and hardware makers in 2023. That view paid off as some valuations soared above historical averages. We are eyeing potential winners further up the technology stack – the layers of technology needed to develop AI applications – and beyond as AI adoption spreads. That’s the case in healthcare, financials and communication services, sectors we like because they have more scope for productivity gains. Outside of tech, those sectors have had some of the most mentions of AI-related keywords in earnings calls and company filings, BlackRock’s Systematic Equity team finds. AI mentions in non-tech sectors have soared 250% since 2022.
In fixed income, we stay neutral long-term US bonds even as 10-year yields have risen this year. We think yields can swing in either direction as policy rate expectations shift in the near term. Long-term yields are moving toward our view that investors will demand more term premium, or compensation for the risk of holding long-term bonds in the long run. Term premium is muted for now. We prefer short-term bonds, euro area high yield credit and emerging market hard currency debt for income.
Our bottom line
US earnings updates this week will be key to see if they can keep topping expectations and buoying risk appetite in a higher-for-longer interest rate environment. We’re overweight US stocks and see the AI theme broadening.
Market backdrop
The S&P 500 slid 3%, led by tech, on jitters before key earnings results this week and rising bond yields. The first direct strikes between Iran and Israel also helped stoke market unease. US 10-year Treasury yields hit a new 2024 high of 4.70% before settling back slightly. Oil prices eased 4% last week after having been pushed higher due to geopolitical unrest in recent months. We think we’re in a world of structurally higher geopolitical risk – and a lower threshold for conflict escalation.
We’re watching this week’s release of March US PCE data, the Federal Reserve’s preferred measure of inflation, for any signs of acceleration or stubborn services inflation. US CPI data showed that core services inflation, excluding housing, ramped up in March – signaling that inflation may not fall as much as markets expected. Elsewhere, we don’t expect the Bank of Japan to hike rates. Markets will likely focus on its updated economic projections and CPI data.
Week ahead
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of April 18, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (US, Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
Global flash PMIs
US durable goods; Japan services PPI
US GDP data
US PCE; Bank of Japan policy meeting; Japan CPI
Read our past weekly commentaries here.
Big calls
Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, April 2024
| Reasons | ||
|---|---|---|
| Tactical | ||
| US equities | Our macro view has us neutral at the benchmark level. But the AI theme and its potential to generate alpha – or above-benchmark returns – push us to be overweight overall. | |
| Income in fixed income | The income cushion bonds provide has increased across the board in a higher rate environment. We like short-term bonds and are now neutral long-term US Treasuries as we see two-way risks ahead. | |
| Geographic granularity | We favor getting granular by geography and like Japan equities in DM. Within EM, we like India and Mexico as beneficiaries of mega forces even as relative valuations appear rich. | |
| Strategic | ||
| Private credit | We think private credit is going to earn lending share as banks retreat – and at attractive returns relative to public credit risk. | |
| Inflation-linked bonds | We see inflation staying closer to 3% in the new regime on a strategic horizon. | |
| Short- and medium-term bonds | We overall prefer short-term bonds over the long term. That’s due to more uncertain and volatile inflation, heightened bond market volatility and weaker investor demand. | |
Note: Views are from a US dollar perspective, April 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
Tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, April 2024.
Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.
| Asset | Tactical view | Commentary | ||||
|---|---|---|---|---|---|---|
| Equities | ||||||
| United States | Benchmark |  |
We are neutral in our largest portfolio allocation. Falling inflation and coming Fed rate cuts can underpin the rally’s momentum. We are ready to pivot once the market narrative shifts. | |||
| Overall |  |
We are overweight overall when incorporating our US-centric positive view on artificial intelligence (AI). We think AI beneficiaries can still gain while earnings growth looks robust. | ||||
| Europe |  |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the US and Japan – our preferred markets. | ||||
| U.K | |
We are neutral. We find attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to fight sticky inflation. | ||||
| Japan |  |
We are overweight. Mild inflation, strong earnings growth and shareholder-friendly reforms are all positives. We see the BOJ policy shift as a normalization, not a shift to tightening. | ||||
| Emerging markets | |
We are neutral. We see growth on a weaker trajectory and see only limited policy stimulus from China. We prefer EM debt over equity. | ||||
| China | |
We are neutral. Modest policy stimulus may help stabilize activity, and valuations have come down. Structural challenges such as an aging population and geopolitical risks persist. | ||||
| Fixed income | ||||||
| Short US Treasuries | |
We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | ||||
| Long US Treasuries | |
We are neutral. The yield surge driven by expected policy rates has likely peaked. We now see about equal odds that long-term yields swing in either direction. | ||||
| US inflation-linked bonds | |
We are neutral. We see higher medium-term inflation, but cooling inflation and growth may matter more near term. | ||||
| Euro area inflation-linked bonds | |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk. | ||||
| UK Gilts | |
We are neutral. Gilt yields have compressed relative to US Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||||
| Japan government bonds |  |
We are underweight. We find more attractive returns in equities. We see some of the least attractive returns in Japanese government bonds, so we use them as a funding source. | ||||
| China government bonds | |
We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper. | ||||
| US agency MBS | |
We are neutral. We see agency MBS as a high-quality exposure in a diversified bond allocation and prefer it to IG. | ||||
| Global investment grade credit | |
We are underweight. Tight spreads don’t compensate for the expected hit to corporate balance sheets from rate hikes, in our view. We prefer Europe over the US | ||||
| Global high yield | |
We are neutral. Spreads are tight, but we like its high total yield and potential near-term rallies. We prefer Europe. | ||||
| Asia credit | |
We are neutral. We don’t find valuations compelling enough to turn more positive. | ||||
| Emerging market - hard currency | |
We are overweight. We prefer EM hard currency debt due to its relative value and quality. It is also cushioned from weakening local currencies as EM central banks cut policy rates. | ||||
| Emerging market - local currency | |
We are neutral. Yields have fallen closer to US Treasury yields. Central bank rate cuts could hurt EM currencies, dragging on potential returns. | ||||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a US dollar perspective, April 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Euro-denominated tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, April 2024.
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the US and Japan – our preferred markets. | ||
| Germany | |
We are neutral. Valuations remain moderately supportive relative to peers. The earnings outlook looks set to brighten as global manufacturing activity bottoms out and financing conditions start to ease. Longer term, we think the low-carbon transition may bring opportunities. | ||
| France | |
We are underweight. Relatively richer valuations offset the positive impact from past productivity enhancing reforms and favorable energy mix. | ||
| Italy | |
We are underweight. Valuations and earnings dynamics are supportive. Yet recent growth outperformance seems largely due to significant fiscal stimulus in 2022-2023 that cannot be sustained over the next few years, we think. | ||
| Spain | |
We are neutral. Valuations and earnings momentum are supportive relative to peers. The utilities sector looks set to benefit from an improving economic backdrop and advances in AI. Political uncertainty remains a potential risk. | ||
| Netherlands | |
We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations than European peers. | ||
| Switzerland | |
We are underweight in line with our broad European market positioning. Valuations remain high versus peers. The index’s defensive tilt will likely be less supported as long as global risk appetite holds up, we think. | ||
| UK | |
We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation. | ||
| Fixed income | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| German bunds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| French OATs | |
We are neutral. Valuations look less compelling following pronounced narrowing of French spreads to German bonds. Elevated French public debt and a slower pace of structural reforms remain challenges. | ||
| Italian BTPs | |
We are neutral. The spread over German bunds looks tight given Italy’s recently higher-than-expected deficit-to-GDP-ratio and a trajectory for the debt ratio in the next few years which is stable at best. Other domestic factors remain supportive, with growth holding up well relative to the rest of the euro area. Italian households are also showing a significant willingness to increase their direct holding of BTPs amid high nominal rates and yields. | ||
| UK gilts | |
We are neutral. Gilt yields have compressed relative to US Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||
| Swiss government bonds | |
We are neutral. The Swiss National Bank has started to cut policy rates given reduced inflationary pressure and the appreciation of the Swiss franc. | ||
| European inflation-linked bonds | |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||
| European investment grade credit | |
We are neutral. We maintain our preference for European investment grade over the US given more attractive valuations amid decent income. | ||
| European high yield | |
We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the US Spreads compensate for risks of a potential pick-up in defaults, in our view. | ||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, April 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
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