By Teresa Rivas
First-quarter earnings season begins in earnest at the end of this week, as a number of big banks deliver their results. Given the strength of the economy, investors are probably feeling generally upbeat about the reports overall.
Although there will inevitably still be winners and losers, it is a Goldilocks scenario more or less without bears, especially for the biggest companies. Three factors underpin the optimism, according to Cayla Seder, macro multi-asset strategist at State Street Global Markets.
"Unwavering faith that the next monetary policy move will inevitably be a shift towards accommodation has been met with strong economic growth which has not spurred rising inflation expectations," she wrote in a research note Monday. "For equity markets, the first quarter of 2024 felt a bit like having your cake and eating it too."
While analysts have reduced their forecasts of earnings ahead of the first-quarter numbers, as they typically do, they are more upbeat than normal. Seder said the average analyst forecast has come down by about 2.5%, less than the historical average of 3.7%.
But she doesn't think that expectations are too high in general. While interest rates remain a burden, and there is a danger that persistent inflation will keep the Federal Reserve from cutting borrowing costs, the economy's underlying strength has helped to offset those concerns.
"We find the parts of the equity market that are best equipped to navigate a longer than expected period of monetary policy stasis are still large cap, quality growth sectors and industry groups," she wrote. "Although valuations are not cheap, we'd argue that they are worth the cost."
Larger companies may be better equipped to handle any pressure that comes with slowing economic growth or the higher cost of raising capital.
Jefferies analysts see opportunities to benefit as well, especially for bigger companies.
"First quarter reporting sees the highest magnitude of estimate revisions, often marking the period when expectations and year-to-date trends are most broadly misaligned," the firm noted on Monday. "As a result, we believe there could be outsized opportunity with respect to stocks poised for shifts to full-year outlooks and subsequent estimate upgrades and downgrades."
Jefferies' analysts identified 22 companies that they think should benefit as changing views lead to higher forecasts for profits, share-price gains, or both. They cited factors ranging from product launches and internal business improvements to conservative financial guidance that could prove to be too downbeat.
Many of those on the list are big companies, or those that look pricey at first blush, following significant stock-price gains.
Take consumer discretionary. Jefferies analyst Corey Tarlowe believes there is a "significant level of conservatism embedded" in Walmart's financial forecasts that could lead to gains for the world's largest retailer. That makes the stock's current valuation -- at 25 times forward earnings, versus its historical average of 23 times -- easier to justify, according to Tarlowe.
Likewise, analyst Ashley Helgans is bullish on e.l.f. Beauty, which has nearly doubled over the past year and now trades at 45 times forward earnings. She believes growth could come in higher than expected as the cosmetics company expands in Europe.
Analyst Alexander Slagle is also upbeat on Domino's Pizza, the largest publicly traded pizza chain, saying investors haven't fully taken note of how it could benefit from a revamped loyalty program.
Separately, analyst Kaumil Gajrawala argued that improving margins and product innovation will lead to greater profitability in the second half of the year for Procter & Gamble. And Ken Usdin wrote that net interest income at JPMorgan Chase -- the nation's largest bank -- would benefit if interest rates remain high as the Fed fights inflation.
Deere, a big industrial name, stands to benefit because investors are too downbeat about its prospects, according to Jefferies. Analyst Stephen Volkmann believes the market has priced in a worse decline in the business for the second half of the year than is likely to happen, he said.
Not all big companies will have something to celebrate, however. Jefferies' analysts see the potential for negative news from companies like Starbucks, Lululemon Athletica, Dollar Tree, Hershey, Etsy, and Paychex.
State Street's Seder believes investors should remain vigilant because stocks' first-quarter gains could fade if rates remain stubbornly high. "We remain cautious given we expect inflation and therefore monetary policy to remain more stubborn than markets believe," she said. "This means the overweight allocation today may erode in the second half of this year if economic data does not cooperate."
It's all the more reason to look for winners today.
Write to Teresa Rivas at teresa.rivas@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 08, 2024 15:25 ET (19:25 GMT)
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