Strong corporate earnings are helping the US avoid a recession - but there are 2 big risks facing markets and the economy, Bank of America says
- Investors shouldn't be so down on corporate earnings as first-quarter results handily beat estimates, BofA said.
- BofA raised its 2023 S&P 500 EPS forecast by 8% and introduced a new 2024 forecast that suggests 9% growth.
- But there are two looming risks that could ultimately rattle the economy and the stock market.
First-quarter earnings results are in, and they're a lot better than Wall Street analysts expected.
Bank of America's Ohsung Kwon said in a Thursday note that corporate America's ability to quickly adapt to a volatile macro environment means investors shouldn't be so negative on the economy given that earnings results beat estimates by 5% as companies begin to focus on productivity and efficiency gains.
"A strong first-quarter once again showed corporate America's ability to preserve margins," Kwon said, highlighting the fact that inflation pressures are easing while pricing power remains on solid footing.
The bank upgraded its S&P 500 2023 earnings per share estimate to $215 from $200 due to the first-quarter earnings strength, representing an increase of 8%. Additionally, Kwon introduced the bank's 2024 S&P 500 EPS estimate at $235, which would represent annual growth of 9%.
"Earnings typically recover stronger than they fall and we expect 2024 to be a better profit environment after companies' focus on efficiency and productivity," Kwon said, adding that a weaker US dollar could also help boost profit growth next year.
Additional upside drivers to corporate profits, the economy, and the stock market include a new capital expenditure cycle that leads to big investments from companies, with an estimated $600 billion in mega projects being announced since January 2021, according to the note.
While the capital expenditure boom is being driven by reshoring efforts, in which companies bring some or all of their production and sourcing capabilities back into America, some is also being driven by over $550 billion in fiscal stimulus that stems from the bipartisan infrastructure bill.
These factors pale in comparison to the main factor that helped boost corporate profits over the past decade: financial engineering in the form of stock buybacks.
"We expect productivity-led earnings growth ahead, rather than financially engineered growth from the last decade," Kwon said.
But there are still two big, long-term risks that could negatively impact the economy and stock market, according to Kwon.
Those risks are the rising trend of de-globalization and refinancing risks due to higher interest rates.
"We are coming out of the best 20-year period for earnings growth, which began with China joining the WTO in 2001. De-globalization is a big secular risk, which drove most of the margin improvement over the past 20 years," Kwon explained.
And while about 75% of corporate America's current debt burden is fixed at historically low interest rates, higher interest rates could still be a headwind for certain sectors, like Real Estate and Industrials, if the Federal Reserve doesn't cut rates in the foreseeable future.
And recent FOMC minutes from the Fed suggest a lot needs to happen for interest rates to be cut anytime soon.
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