Why this bull could have room to run

by Jurrien Timmer, Director of Global Macro, Fidelity Management & Research Company

US markets could soon notch new records as solid earnings and consistent valuations lead to a broader market rally.

Key takeaways

  • Stocks are trading at record highs.
  • Earnings—not expectations for rate cuts or any other factor—have been the main force driving markets higher.
  • There are risks, but I think these valuations are justified and earnings strength could sustain the rally.

The Dow has surged near 40,000 and the S&P surpassed 5,100. Take a moment to let that sink in. The rally for stocks has been furious since the October 2022 near-term bottom, and if you are wondering if stocks can push even higher, I believe persistently solid earnings are the main reason why the rally could continue.

Earnings are the best reason to be bullish

As of late February, 450 out of 500 companies have reported Q4 earnings and 76% beat estimates by an average 757 basis points. What does that mean? This Q4 earnings season has been solid.

Consider that year-over-year earnings growth rate was forecasted to be 1% at the start of this earnings season. It’s now closer to 8%. Following 2023’s modest −2.6% earnings decline, the 2024 calendar year estimate is now ticking higher at 9.5%. You can list all the other factors for why stocks are trading at all-time highs: Expectations for rate cuts, more distance from the pandemic, an improving outlook on capital expenditures, you name it. Above all these factors is earnings strength, and I think it’s likely to continue.

Shrinking recession and valuation worries

It's interesting to me now that there was real (and justified) concern about a recession potentially wreaking havoc on markets and the economy. Correctly or not, the market is betting on a soft landing. Perhaps that recession is still around the corner, but for now, the juxtaposition of the P/E expansion in 2023 followed by an earnings recovery in 2024 has a distinct early- or mid-cycle feel to it.

With US stocks at all-time highs, I’m taking a close look at how earnings expansions and valuations have interacted in the past during mid-cycle soft landings. This juxtaposition has almost always happened during either an early-cycle recovery or a mid-cycle soft landing, and almost never during late cycle (except for 1989, when the market was recovering from the 1987 crash and was about to be hit by the Savings and Loan crisis in 1990). The 4 soft landings in 1966, 1984, 1995, and 2016 all happened during mid-cycle.

What does all this mean? I don’t think we’re going to fall back into a recession in this cycle. Of course, it’s possible we’re not giving enough weight to how unique circumstances are now relative to past cycles that we’re trying to compare this one to. Did the pandemic and all the fiscal stimulus that it unleashed render the traditional business cycle moot? Has the baton been passed from monetary dominance to fiscal dominance? Could this rally be all artificial intelligence hype and “Magnificent 7” dominance that is skewing the picture? It’s possible, but I don’t think so.

It's not just tech stocks

One trend that’s making me even more optimistic is market breadth. Remember, much of 2023’s gains were due to a huge rally for big tech, with far fewer gains seen across the rest of the market. Market breadth has improved substantially this year, and it seems like only a matter of time before the broader market will confirm the new highs in the S&P 500. To wit, the S&P 500 equal-weighted index is now a mere 100 points (−0.7%) below its all-time high from early January 2022. In total return terms, it has already bested the January 2022 peak by 3.5%. This demonstrates relatively strong market breadth, which is typically viewed as helpful for sustaining rallies.

While the AI narrative continues to dominate the conversation, the market is less narrow than it might seem. Last week, for example, the dispersion of returns among the 11 S&P sectors was only 1%, despite the Magnificent 7 dominating the headlines and the S&P 500 posting a 1.8% return. If this was late 1999, these numbers would show more dispersion. This is evidence to me that the bullish broadening is happening.

Investing implications

Of course, now is not the time for complacency. Markets have a way of humbling us all, and I’m watching what’s happening around the world with a bit of bated breath. With that said, I think this bull has legs, and its earnings that have me riding the growing wave of positive investor sentiment.



Copyright © Fidelity Management & Research Company

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