While major stock market indices have rallied this year, investors continue to receive mixed signals from the economy. On the one hand, inflation is improving which has allowed interest rates to stabilize at a lower level. On the other hand, last week's jobs report was a significant surprise to the upside with 517,000 net new jobs created in January and the unemployment rate falling to 3.4%, the lowest in over 50 years. Although the inflation data suggest the Fed could slow or pause its rate hikes, the jobs data mean that they may need to keep their guard up. This uncertainty creates confusion as markets adjust to financial conditions.
Just as many economists expect flat or slightly negative economic growth in 2023 before seeing a recovery in 2024, many expect earnings growth to be meager this year as well. In this way, both sets of data point to a "reset" as the world adjusts to the shocks of the past few years.
If inflation continues to slow, costs may improve and help support profitability across companies of all sizes. After all, rising costs due to higher goods prices and growing wages have crimped earnings over the past year. Similarly, if consumer confidence returns and spending rebounds, this could help prop up earnings.
This is a balancing act since the flip side of consumer spending is wage growth, which represents higher costs for businesses.
It is also positive that seven of the eleven S&P 500 sectors are expected to experience positive earnings growth over the next year, despite the challenging environment. The exceptions are the commodity-sensitive materials and energy sectors which benefited from rising prices last year, and the real estate sector which has been directly directly hit by rising rates.
It's important to keep in mind that analyst forecasts are not always accurate and are subject to change based on economic conditions. Still, expectations for this year align with slower growth trends across the economy. However, they also suggest that earnings could rebound once the underlying fundamentals improve and inflation stabilizes. Either way, record earnings continue to support valuations which are the most attractive in years.
The bottom line? To cut through the noise, investors should continue to focus on fundamentals such as earnings as the Fed and inflation stories play out.