Higher Corporate Revenue Boosts Stock Market Outlook

Stock Market: A larger share of revenue at big U.S. companies is beginning to reach the bottom line, a potentially encouraging sign for a stock market that has been stuck in neutral in recent weeks.

As the first-quarter earnings season surpasses its halfway point, the net profit margin of companies within the S&P 500 has increased to 11.5% from 11.3% in Q4, according to actual results and estimates for unreleased reports. The margin is beginning to tick upwards, a promising sign for the stock market that has been stuck in a neutral position recently. After six quarters of sequential decline, this is the first time margins have seen an increase, which potentially indicates that margins have hit a bottom, said John Butters, senior earnings analyst at FactSet.

The second quarter of 2021 saw net profit margins peak at 13% before descending, and the current improvement in margins provides consolation to investors who have been attempting to assess the economy’s trajectory while the Federal Reserve continues raising interest rates. Although it is still early to tell if the cost pressures will subside in the long term and corporate profits will start rising again, the latest earnings season appears to be shaping up better than anticipated, with profits projected to have dropped by 2.9%. With almost 70% of the companies in the S&P 500 having announced their results, this improvement is significant from analysts’ forecasts for a 6.7% decline at quarter-end.

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Despite this improvement, many companies are still cutting costs, with inflation levels remaining elevated and wage gains picking up in the first quarter. For example, 3M recently announced the elimination of 6,000 additional jobs, on top of the 2,500 positions it announced in January, to streamline its corporate operations, simplify its supply chain and reduce management layers. The company’s earnings have declined by 25% while it battles soft demand for its products, leading to a 15% decline in 3M shares this year.

Similarly, Tyson Foods has announced the elimination of 15% of its senior leadership positions and 10% of its corporate roles, with its stock declining 3.4% this year. The largest US meat supplier by sales has been under pressure due to higher costs across its business.

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The Federal Reserve recently raised interest rates by an additional quarter-percentage point to a range between 5% and 5.25%, a 16-year high. The decision marked its tenth consecutive rate increase, aimed at battling inflation and making investors more anxious about the possibility of the economy slipping into a recession. A recession would likely result in bad news for both the stock market and corporate earnings, with the S&P 500 declining a median of 24% in recessions going back to 1946, according to research from Deutsche Bank.

Despite the potential for economic decline, economists expect any recession this year to be relatively quick and shallow. On the earnings front, analysts predict a fall in profits again in the current quarter before they begin climbing in the second half.

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Although investor sentiment remains bearish, which is typically a contrarian indicator for the market, there is hope that it may shift. The latest survey from the American Association of Individual Investors showed that 38.5% of investors are bearish about the direction of the stock market, above historical levels, though improved from March.Head of the public markets group at U.S. Bank Wealth Management, Lisa Erickson, advises investors to be more defensive. Bank Wealth Management, recommending that investors hold fixed-income assets as well as stocks in the real estate and infrastructure industries for their steady dividend payments in an uncertain economic environment.

Overall, stocks still appear expensive, with the S&P 500 trading at around 18 times its projected earnings over the next 12 months, higher than the 10-year average of 17.3. Despite this, the bearish sentiment and