The year has started on a positive note for the stock market, with the S&P 500 posting a 1.4% gain in the second busiest week of earnings season. However, the returns seem to be concentrated in the largest stocks, particularly what is dubbed as the 'Magnificent 7'. These seven companies - Microsoft, Meta Platforms, Amazon.com, Apple, NVIDIA, Alphabet, and Tesla - have shown strong performance, contributing to the overall market growth. In contrast, smaller companies and the average stock have struggled to keep pace, with some even experiencing losses.
While the S&P 500 has delivered a solid 5.5% return year-to-date, the average stock has only seen a marginal increase of less than 1%. The Russell 2000, representing smaller companies, has actually declined almost 1% during this period. This concentration of returns highlights the disparity in performance within the market and raises questions about broader market participation.
Despite limited economic data releases last week, the probability of a Federal Reserve rate cut in May has fallen, with the market now placing the odds at nearly 50-50. This shift is attributed to the positive economic growth and comments from Fed Chair Powell dismissing the need for an immediate rate cut in March. Alongside this, the 10-year U.S. Treasury yield has risen by 30 basis points year-to-date, reaching 4.18%. The increase in yields has put pressure on interest rate sensitive stocks such as banks, utilities, and real estate. However, the market leaders, including the Magnificent 7, have remained largely unaffected, as the rise in yields has been driven by improving economic growth expectations rather than inflation. This bodes well for corporate earnings, as stronger real growth tends to result in better financial performance for stocks.
Earnings season, which is nearly two-thirds complete, has shown considerable improvement compared to the dismal start by banks. According to FactSet, the financials and industrial sectors have been the primary contributors to the enhancement in the headline growth rate. Notably, insurance companies within the financial sector have played a significant role in boosting earnings. Sales growth, closely linked to nominal GDP growth, has also shown positive signs, surpassing expectations before the earnings season commenced.
As we move into this week, companies such as Coca-Cola, Kraft Heinz, Cisco Systems, and Occidental Petroleum are scheduled to report their earnings. These announcements will further shape the overall earnings landscape for the quarter. Despite a slow start, the blended earnings growth rate for the S&P 500 in the fourth quarter currently stands at 2.9% year-over-year, surpassing the initially estimated growth rate of 1.6%.
While improving expectations for U.S. economic growth have pushed bond yields higher and lowered the likelihood of a rate cut by the Federal Reserve in the first half of the year, the overall picture for earnings has been positive. The higher yields, driven primarily by improving growth expectations, have hindered some interest rate sensitive sectors of the market, but provided a favorable environment for stocks overall. As we eagerly await economic indicators such as January consumer inflation and consumer spending data, they will help gauge the state of the economy and potentially shed light on the timing of future Fed easing.
Note: Glenview Trust, an investment firm, discloses their holdings of various companies mentioned in this article as part of their recommended investment strategies.
