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A pivotal $40 trillion week ahead for high-flying stocks

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2023-07-25

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The upcoming week holds significant importance for global stocks, as companies with a combined market value of $US27 trillion (A$40 trillion) prepare to announce their quarterly earnings.

Last week, both Netflix and Tesla demonstrated the high stakes involved—a stellar performance could lead to soaring stocks, while any disappointments may trigger a sharp sell-off.

As this earnings season began, investors were optimistic, anticipating central banks to pause interest rate hikes and hoping for continued economic growth in the US.

Despite the steady downward revision of near-term earnings estimates, the MSCI All-Country World Index's year-to-date gains surpassed 15 per cent, and the S&P 500 traded at nearly 20 times forward earnings, indicating a premium in its long-term valuation.

Now, with earnings announcements on the horizon, investors are keenly waiting for companies to deliver strong results.

Over 500 major companies worldwide are set to reveal their performance this quarter and provide insights into their future prospects. This busy week of earnings reports includes major players such as Microsoft, Google-parent Alphabet, LVMH, Banco Santander, Volkswagen, Airbus, Sanofi, and Samsung.

According to Michael Wilson from Morgan Stanley, relying solely on cost-cutting measures won't be enough to drive stocks further. The lofty valuations now demand "more confirmation of the upturn in growth that consensus expects in the second half," he advised his clients in a note.

Wilson, known for his cautious outlook on US equities, pointed out that impressing investors has become more challenging. Though S&P 500 earnings have generally surpassed estimates this season, the percentage of stocks with a positive post-earnings reaction decreased to 42 per cent, compared to 49 per cent in the previous quarter, as per Morgan Stanley's analysis.

"This aligns with our thesis that 'better-than-feared' results likely will not be sufficient to materially boost performance post reporting," Wilson added.

Last week, the earnings reports from Netflix and Tesla—a duo of influential Big Tech mega-caps—highlighted how markets can react to earnings or guidance shortfalls. Both companies enjoyed significant gains earlier in the year, but Netflix's third-quarter sales guidance fell short of Wall Street estimates, and Tesla warned of potential profit impacts. This triggered a broader selloff, causing the Nasdaq 100's market capitalisation to plummet by more than $US400 billion in a single day.

James Athey, investment director at Abrdn, expects a substantial portion of earnings to surpass estimates, but he cautioned that this may not be sufficient to satisfy the lofty valuations in the market.

"If guidance shows any sign of concern, that could be enough for investors to flee those stocks."

The stakes are particularly high for heavyweight US technology firms, responsible for propelling the Nasdaq 100's impressive 41 per cent gain this year. The so-called "magnificent seven"—Apple, Amazon, Nvidia, Facebook-parent Meta, Microsoft, Alphabet, and Tesla—currently trade at a record premium to the bottom 493 stocks in the S&P 500, as per Bank of America strategist Savita Subramanian.

Bloomberg Intelligence strategists Gina Martin Adams and Gillian Wolff also identify further valuation risks should the Federal Reserve keep rates higher for an extended period. Though the US central bank is expected to deliver a quarter-point rate hike this week, strong labour market data has sparked concerns about potential further tightening later in the year. The rate-hike expectations that dominated earlier this year have mostly dissipated.

On the contrary, Goldman Sachs strategists maintain a more positive outlook, deeming the S&P 500's high valuation reasonable and projecting potential further growth this year as previously lagging index components join the surge driven by artificial intelligence winners.

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