The stock market isn’t the economy and a services boom won’t fuel S&P 500 earnings

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For a stock to become multi-bagger, what ultimately matters is the company’s earnings growth rate. Several factors could affect the stock price in the short term, but in the long term, it is earnings that drive the stock price higher. In the current economic environment, overall corporate profits are down. The impact could be seen in the declining performance of major US indices.

BlackRock Investment Institute in its weekly commentary says they see corporate earnings deteriorating amid spinning consumer spending and a hesitant restart. This is partly why they remain cautious about equities. Stocks are rallying as markets think inflation is falling and the Fed will soon slow the hikes. BlackRock does not believe the rally is sustainable as they see the Fed raising rates to levels that will stall the economic restart.

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Jerome Powell, in his recent keynote at the Jackson Hole Economic Policy Symposium 2022, also warned of challenges ahead for the economy as rate hikes will continue to keep inflation in check.

One of the main reasons for the stock market crash since January 2022 is inflation which leads to higher yields. But, a big reversal occurred from the June lows. The stock market rally that saw the SP500 rise 17% from June lows may not be sustainable. According to BlackRock’s commentary, “Stocks jumped on hopes that the Fed will halt hikes as soon as inflation drops. We believe this is premature and see inflation settling above pre-Covid levels”

BlackRock’s commentary goes on to say that corporate earnings could weaken further as consumer spending shifts and profit margins shrink. This is not a typical business cycle, so we expect differentiated regional and sectoral effects. The risk of disappointing results is one reason why we are tactically underweight equities.

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The pandemic and the unique restart of economic activity have led to a massive reallocation of resources. During the pandemic, consumer spending has shifted toward goods and away from services. This has supported the incomes of goods producers.

That is changing, in our view. The demand for goods is weakening. Overstocked inventory, from retailers to semiconductor companies, is proof of that. During this time, the expenses go back to the services. This change could affect equities. Why?

Goods-related earnings are expected to account for 62% of S&P 500 earnings this year, compared to 38% related to services. Moreover, the stock market is not the economy, claims BlackRock’s commentary. Goods accounted for less than a third of the US economy in the first half of this year. This means that a services boom does not fuel S&P 500 earnings as much as it does the economy.

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