FANG Stocks Save the Week

In a week where equity investors got spooked by higher rates and peaking growth, robust earnings from tech giants fell just short of keeping the market afloat.

Stocks got slammed Tuesday when Caterpillar’s “high water mark” comments on profit came just hours after the first 3 percent yield on 10-year Treasuries in four years. It took earnings-fueled rallies from heavyweights Facebook and Amazon in the final two days to save the S&P 500 from a rout in the week.

Gone from what’s so far been the best
earnings season
on record is the once-unbridled confidence in economic growth that sent equities to all-time highs in January. In its place is the fear that corporate profit can only go downhill if the bump from tax cuts is over and higher borrowing costs cause trouble for an economy that’s already
showing signs
of slowing.

Growth in Debate

Bulls point to continued profit expansions while bears caution over slowdown

Source: Bloomberg

The mood shift has sparked a debate on whether the nine-year bull market can continue its run toward the longest in history. Bears argue earnings forecasts are too optimistic with signs mounting global growth is slowing. Bulls say the concerns are overblown.

“Every meeting we have, it’s a big discussion about how close we are to reaching the end of the cycle,” James Barty, Bank of America Corp.’s head of global cross-asset and European equity strategy, said in an interview with Bloomberg TV. “I think it’s a couple years away, far too early to get defensive.”

One indisputable fact is that
aren’t going to collapse any time soon. In fact, analysts expect S&P 500 companies to report double-digit growth every year through at least 2020. While rising bond yields threaten the allure of equity income, stocks are getting cheaper with prices stalling while earnings keep rising.

The S&P 500 fell less than one point over five days, ending the week just 0.5 percent higher than where it started the reporting season on April 13. The Dow Jones Industrial Average slipped 0.6 percent for the first decline in three weeks. The Nasdaq Composite Index lost 0.4 percent.

Stocks have failed to capitalize on an unprecedented rate of positive surprises as investors are reluctant to reward earnings beats. At 80 percent, the proportion of S&P 500 firms exceeding analyst estimates is higher than at any time in the past 25 years. Yet their stocks rose a paltry 0.3 percent on average in first-day reactions.

One bearish case against buying into the robust growth story is that it may not last. Around the world, economic data are trailing forecasts, casting a shadow on the synchronized recovery that propelled the equity rally last year. At the same time, cost pressure from wages and raw materials seems to be gaining momentum.

Analyst earnings estimates look too optimistic, particularly when borrowing costs are rising, according to Societe Generale. The firm studied the 10-year Treasury yield and corporate profits and found they have shown an inverse relationship over the past three decades.

Specifically, when yield was above the three-year average, as is the case now, earnings tended to expand an average of about 2 percent in the subsequent three years. That’s less than a third of the pace seen when yield was lower.

Strategists led by Alain Bokobza warned that the S&P 500 could fall as much as 18 percent should profits stay flat in 2019 and 2020.

“Optimism on earnings from 2019 onward might be misplaced,” the strategists wrote in a note to clients Friday. “Any lowering of near-term earnings growth expectations could be a potential trigger for an equity market correction.”

Not everyone is as pessimistic. Laszlo Birinyi, a steadfast bull during the nine-year U.S. equity rally, is sticking to his forecast that the S&P 500 will rise back toward its January peak, hitting 2,860 by June.

While Apple shares have lost more than 10 percent from a March high heading into next week’s earnings report, Birinyi said his firm is holding on to the stock because concern over iPhone X demand is nothing new and the company’s product launches have always been greeted with skepticism.

Meanwhile, concerns over a global slowdown look unwarranted to Birinyi, who observed that shares of luxury-goods producers are rallying. LVMH, owner of the Louis Vuitton brand, has jumped 17 percent this year while Gucci’s parent company Kering SA is up 22 percent.

“If this segment of the market is doing well, we have to be encouraged about the economy,” Birinyi said. “Investors should look through the current storm clouds, but not ignore them, as we continue to expect higher prices.”

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