Some investors in the U.S. stock market have been worried that falling prices could hurt stocks because companies may not be able to charge as much, which would hurt their future earnings.
However, strategists at BofA Global Research say that there isn’t any data to support the claim that disinflation could hurt the finances of American businesses.
The weak inflation data from last week showed that we’re moving towards a Goldilocks situation… “But there are worries that disinflation is becoming a bigger drag on earnings, since earnings are nominal and higher inflation leads to faster earnings growth,” wrote Ohsung Kwon and Savita Subramanian in a client note on Monday.
On the other hand, demand and economic growth, not prices, determine corporate earnings. This is because prices have only been a lagging indicator with “no statistically significant relationship” to earnings, according to the strategists.
Kwon and Subramanian said that while there was a strong link between a company’s revenue and both the consumer-price index and the producer-price index, there was “absolutely no link” between the two and earnings growth.
The best correlation between real GDP growth and the S&P 500’s quarterly earnings growth is seen in real GDP growth, not in nominal GDP, CPI, or even PPI, according to BofA strategists.
Kwon and Subramanian also said that inflation has historically been a late sign of corporate earnings. It was written that the CPI and the PPI are five and three quarters behind the correlation between S&P 500 earnings and inflation.
This week, more companies are starting to report earnings, which will put the seemingly unstoppable rise in U.S. stocks to the test.
It may seem like the “Magnificent Seven” tech stocks are responsible for the S&P 500’s meteoric rise this year. However, the other 493 companies are set to report their first year-over-year quarterly earnings growth since the fourth quarter of 2022, according to BofA strategists.
For the Magnificent Seven, on the other hand, Kwon and Subramanian say that earnings growth will slow for the second quarter in a row. “Because there is a strong link between Big Tech’s stock performance and its earnings, we think that the narrowing growth differential will cause the market to widen,” they wrote.
The strategists now think that the S&P 500 will earn 9% more in the second quarter of 2024, which is 2% more than they thought. In the past, a 2% beat has been the norm. However, a 2% beat would be the smallest quarterly earnings beat since the fourth quarter of 2022.
In addition, Kwon and Subramanian said that a slowing economy and rising earnings could be great for U.S. stocks. “Historically, a backdrop of slowing GDP and rising EPS [earnings-per-share] has been the best macro environment for stocks, leading to a low rate environment and strong fundamentals,” they said.
Data from FactSet shows that U.S. stocks ended the day higher on Monday afternoon. The Dow Jones Industrial Average DJIA rose 0.5% to set a new record, while the S&P 500 rose 0.3% and the Nasdaq Composite COMP went up 0.4%.
