Investors are facing a ‘make or break’ 3rd-quarter earnings season as supply-chain issues and labor costs mount, Bank of America says

woman factory worker car
  • Bank of America sees S&P 500 earnings growth for Q3 but increasing pressure from supply-chain issues and higher wages.
  • Guidance in quarterly financial reports could be ‘ugly,’ said BofA strategist Savita Subramanian.
  • BofA sees Q3 earnings in line with Wall Street’s consensus estimates vs. a 17% beat in Q2.

Corporate America is on course to continue posting earnings growth for the third quarter of 2021, but investors should brace for companies to issue disappointing guidance as they contend with supply-chain bottlenecks and rising wages, said Bank of America.

The third-quarter earnings season will get underway this week with reports due from 10% of S&P 500 companies, mainly financial firms like JPMorgan Chase & Co., Goldman Sachs, Citigroup, and Wells Fargo.

BofA in a note Monday called the third quarter a “make or break” period for earnings. It said Wall Street is looking for S&P 500 companies to turn in average earnings of $49.06 a share, up 27% from a year ago when the US economy was beginning to rebound from its COVID-driven recession. That would mark a slowdown from a second-quarter earnings expansion of 88% that led companies overall to beat expectations by 17%.

“With the strong beat, 3Q EPS estimates have risen 3% over the past three months, but we see increased headwinds heading into 3Q, primarily driven by supply chain issues, delta-driven slowdown, and continued inflationary pressure,” said Savita Subramanian, head of US equity and quantitative strategy at Bank of America Global Research.

BofA, which lowered its third-quarter per-share earnings projection by $2 to $49, sees earnings for the period meeting analyst expectations but guidance could be “ugly,” the strategist said.

Subramanian said while margins in the second quarter expanded to record highs, companies pointed out difficulty passing through cost inflation.

“Since then, issues have worsened: supply chain news stories increased 74% and freight rates from China rose 20%, with record backlogs at the West Coast Ports,” she wrote. Supply issues mostly led to a near-record number of profit warnings in the third quarter.

Numerous industries have been hurt by a range of supply-side disruptions such as chip shortages, a jump in costs for shipping and prices for raw materials, and pay hikes to alleviate laborforce shortages.

Wage inflation “is just as big of a headwind (if not bigger)” than supply-chain problems, as the US Bureau of Economic Analysis estimates wages are as much as 40% of total private sector costs, said BofA. The bank also sees earnings risks from slowing growth in China and higher oil and gas prices.

“Demand remains robust but soaring inflation poses downside risks. While analysts have baked in margin contraction this quarter … we see big risks to 2022 numbers, where analysts expect record margins,” said Subramanian.

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Bank of America outlines what could make or break an investor’s ability to generate positive stock-market returns over the next decade

NYSE trader
New York Stock Exchange.

  • The buy-and-hold investment strategy that has worked so well may be at risk over the next decade, Bank of America said in a Friday note.
  • The bank forecasts a flat return for the stock market over the next 10 years, unless dividends are reinvested.
  • “The simple act of reinvesting dividends could yield a total return equivalent to the S&P 500 at 6,000 in 2031,” BofA said.
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Investors conditioned to buy stocks and hold for the long-term may be in for a decade of pain if Bank of America’s outlook proves correct.

Led by equity and quant strategist Savita Subramanian, the bank highlighted that its valuation model is currently forecasting a flat return over the next decade for stocks – or 0% – according to a Friday note that cited supply-chain woes and peak globalization.

“COVID-related supply chain issues have spread beyond consumer goods. And longer-term signs of global friction are easy to find. But risk premia barely reflects this,” Subramanian explained.

To combat the potential 0% returns over the next decade, BofA says the number one thing an investor can do is reinvest their dividends.

“The simple act of reinvesting dividends could yield a total return equivalent to the S&P 500 at 6,000 in 2031, assuming long-term average growth and payouts,” the note said.

Hitting that mark in the next 10 years would represent a total return of only 36% for the S&P 500, or an annualized gain of about 3%. That’s just a fraction of the past decade’s return of 360%, representing an annualized return of about 16%, according to data from Koyfin.

But with stocks expensive on nearly every metric, “double digit gains from the benchmark may be hard to repeat,” Subramanian said.

While BofA’s outlook is much bleaker than recent history, it would continue a decades-long trend of dividends driving much of the stock market’s return. Since 1970, 84% of the total return of the S&P 500 can be attributed to reinvested dividends, according to data from Morningstar and Hartford Funds.

To enable dividends to be automatically reinvested, an investor can contact their broker or enable the option online. And if fractional share trading is allowed, investors can manually purchase fractional shares whenever a dividend is paid to their account.

For example, every time Apple pays its quarterly dividend of $0.22 per share, an Apple investor will automatically buy .0015 shares of Apple. Then, compound interest will do the rest of the work.

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3 reasons why energy is the best sector of the stock market to invest in right now, according to JPMorgan

Oil rig sunset background
Oil rigs.

  • The sharp outperformance in energy stocks this year is likely to continue, JPMorgan said in a note on Thursday.
  • The bank named the energy sector as one of its favorites and said it offers an attractive risk vs. reward profile.
  • These are the 3 reasons why JPMorgan is advising its clients to invest in energy stocks.
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It’s not too late for investors that missed out on this year’s best-performing sector to gain some exposure, JPMorgan said of energy stocks in a note on Thursday.

The energy sector is up about 50% year-to-date, nearly triple the S&P 500’s 17% gain over the same time period. But there’s still room for energy stocks to play catch-up to the broader market when looking at a longer time horizon, the bank noted. Since 2014, the energy sector is lagging the broader market by a whopping 183%.

JPMorgan sees gains continuing for energy stocks as a supply crunch pushes oil, natural gas, and even coal prices through the roof. Those prices could continue to creep even higher, as JPMorgan sees oil potentially surging to $130 per barrel.

The energy sector offers an attractive risk vs. reward profile to investors thanks to three key reasons: low valuations, improving fundamentals, and increasing capital returns, JPMorgan said.

In fact, valuations of energy stocks are so low that the sector represents only about 3% of the S&P 500 today, down from about 20% at one point, the analysts noted. That leaves significant runway for the sector to increase its value as favorable economics wash over energy companies amid a surge in oil prices.

“As is usually the case with commodities, we expect the energy recovery to be swift and more extreme than post-bust rebounds seen in other asset classes such as commercial real estate during the 1990s, during the 2000s, and financials/housing during the 2010s,” JPMorgan said.

The bank said investors looking for the most upside potential in the sector should buy small-cap energy stocks. That’s because they have higher sensitivity to rising oil prices, are undergoing a balance sheet recovery, and are potential merger targets as larger peers look to build up their reserves.

And many of the risks that have scared investors out of energy stocks over the past few years, like regulations, the rise of ESG investing, and a surge in electric vehicles, are actually catalysts for buybacks and dividends.

Those factors are “helping bring much needed discipline to the sector with a focus on reducing debt and returning excess shareholder capital rather than higher market-share and production,” JPMorgan said.

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Depressed investor sentiment amid recent volatility is flashing a contrarian signal pointing to more upside ahead for the stock market

NYSE Trader surprised
  • Investor sentiment remains bearish despite the S&P 500 being just 3% below its record high.
  • Fearful investors and the absence of euphoria represents a buy signal for contrarian investors.
  • Bullish investor sentiment fell for the third week in a row and are well below the historical average in AAII’s most recent survey.
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Stocks have historically climbed a wall of worry. And from rising inflation to a US debt ceiling showdown, right now there is no shortage of worry weighing on investors.

That’s why there could be more upside left in the stock market, as the absence of euphoric sentiment among investors flashes a buy signal for contrarians.

In fact, even as the S&P 500 trades just 3% below its record high, there is plenty of bearish sentiment. For example, CNN’s Fear and Greed Index remains in “Fear” territory with a reading of 34 on Thursday. That’s much worse than last month’s neutral reading of 53, and slightly less fearful than last week’s “Extreme Fear” reading of 25.

The whiplash in investor sentiment over the past month came amid a stock market sell-off that saw the tech-heavy Nasdaq 100 fall nearly 8% from its record high. While the debt ceiling showdown between Republicans and Democrats in Congress contributed to the volatility, so did a swift jump in interest rates, oil prices, and inflationary data.

AAII’s investor sentiment survey is also backing up the bearish sentiment found in CNN’s Fear and Greed Index. For the week ended October 6, bullish investor sentiment fell to 25.5%, well below the historical average of 38%, and representing the third weekly consecutive drop in bullish sentiment. It was also the fourth consecutive week with bullish sentiment below its historical average.

Finally, Google search trend data for “dow jones” is declining, which DataTrek co-founder Nicholas Carson says is a bullish indicator for stocks. The thinking goes that spikes in stock market volatility lead to Main Street investors panic-searching for answers, while a steady decline in searches represents a sign that consumer confidence is back on the rise.

Since peaking in late September, Google search interest for the term “dow jones” has declined by 32%, suggesting that the consumer is now less focused on stocks and could instead be shifting attention to the upcoming holiday spending season. That would line up with a seasonally bullish year-end period for stocks.

Fundstrat’s Tom Lee has echoed the potential for a bullish turnaround in the stock market going into year-end, arguing that the S&P 500 could climb the ongoing wall of worry and surge to 4,700, representing an additional 6% upside from current levels.

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Runaway inflation isn’t a concern and mega-cap tech can power stocks higher despite rising interest rates, Fundstrat’s Tom Lee says

Tom Lee
Fundstrat’s Tom Lee.

  • Mega-cap tech stocks can continue their rise even amid rising interest rates, Fundstrat’s Tom Lee told CNBC on Friday.
  • That line of thinking is contrarian to the often impulse sell-off seen in tech stocks whenever interest rates move higher.
  • Lee also thinks investors can rest easy as he doesn’t see runaway inflation unfolding in the US.
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Two of the biggest stock market risks worrying investors right now don’t concern Fundstrat’s Tom Lee, according to a Friday interview with CNBC.

Inflation has been on the rise amid supply-chain disruptions from the COVID-19 pandemic and increasing wage pressures. Core inflation rose 3.6% in August, representing the biggest year-over-year jump in more than 30 years.

That’s leading some investors to worry that rising inflation is not as transitory as Fed Chairman Jerome Powell may think.

Higher inflation puts upward pressure on interest rates, which sparked a steep sell-off in mega-cap stocks this week after the 10-Year US Treasury yield jumped to the the highest level in more than three months.

Lee admits runaway inflation would reprice the stock market lower. But the fear of it actually happening – and then hitting tech stocks via rising interest rates – isn’t fazing him.

That’s because Lee doesn’t think wage growth is sticky. Job turnover is picking up across many industries, and wage growth may be high now due to shortages but won’t be at those same rates in a few years, he said.

Population growth is another important factor to consider when forecasting future inflation. And right now, the US is stalling, with 2020’s population gain the slowest since the Great Depression.

“The biggest risk would be if the US population was growing faster, because that’s how you anchor increasing wage expectations. There really hasn’t been any country with slow population growth that has had sustained inflation. It’s one of those misconceptions because people think [inflation] is purely a monetary phenomenon,” Lee explained.

“I think investors have more anxiety about inflation risks than the actual realized risks will be,” Lee added.

Stock market outlook: still bullish on S&P 500, FAANG

Rising interest rates don’t yet pose a threat to the S&P 500’s current bull market run because they are still sitting at historically low levels, Lee said.

Ten-year Treasury yields of 1.5%-2% won’t burden companies, homeowners, or people with debt, and won’t hold back stockholders, he predicted.

And while a spike in interest rates has often led to a steep sell-off in high-growth technology stocks, Lee said a continued move higher in rates won’t stop tech stocks from powering the S&P 500 to his year-end price target of 4,700, representing potential upside of 9% from Thursday’s close.

“The fundamental question is going to be are FAANG margins at risk because [interest] rates rise? Operating margins could actually rise if rates are rising, and FAANG’s relative performance during periods of inflation is actually pretty good,” Lee explained, citing internal research.

And because FAANG is not as crowded a trade as it was last year during the stay-at-home stock boom, they can still rally strongly into the end of the year, Lee said.

The current 5% sell-off in the stock market is “just a squiggle, and as we zoom out it’s going to look like nothing in 12 months,” Lee concluded.

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Investors should hold onto their high-growth tech stocks even as interest rate volatility batters the sector, Goldman Sachs says

A trader works on the floor at the New York Stock Exchange (NYSE) in New York, U.S., March 4, 2020. REUTERS/Brendan McDermid
A trader works on the floor at the NYSE in New York.

  • Investors should hold on to their high-growth tech stocks despite this week’s interest rate-induced sell-off, Goldman Sachs said.
  • The bank said the velocity of rate spikes has a bigger impact on high-growth stocks than the absolute level of interest rates.
  • “Our overall macro outlook of low rates and low trend economic growth supports maintaining longer-term positions in high quality secular growth stocks,” Goldman said.
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A spike in interest rates sparked a deep sell-off in technology stocks on Tuesday, but Goldman Sachs says investors should still hold onto their high-growth stocks for the long-term, according to a Tuesday note.

The 10-Year US Treasury yield hit a 3-month high of 1.56% on Tuesday, sparked by fears of rising inflation and uncertainty towards Congress’ ability to raise the debt ceiling before the Treasury runs out of money in mid-October.

But interest rates are still historically low, and a low economic growth environment in the long-term should support valuations for high-quality, high-growth stocks that are benefiting from secular trends, according to Goldman.

“Our overall macro outlook of low rates and low trend economic growth supports maintaining longer-term positions in high quality secular growth stocks,” analysts said.

For now, cyclical stocks may outperform longer-duration technology stocks in the short-term if interest rates continue to rise. But that outperformance will be “more muted” in today’s environment than it was earlier this year due to expectations of slower economic growth, according to Goldman.

In fact, September’s surge in interest rates is less extreme than the interest rate spike seen earlier this year, when a spike in the 10-year yield was in part driven by expectations of a quick vaccination roll-out and a strong rebound. That view has since shifted lower.

“Today, economic growth is decelerating, the FOMC is expected to announce the start of tapering at its November meeting, and our economists have downgraded China’s economic growth forecasts,” Goldman said.

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Investors should buy any dip in the market as declining COVID-19 cases spur fresh gains for stocks, JPMorgan says

NYSE Trader
A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S., March 9, 2020.

  • Investors should treat any sell-off in the stock market as a buying opportunity, according to a Monday note from JPMorgan.
  • That’s because a likely decline in COVID-19 cases will help spur economic growth and drive stocks higher.
  • “We now think that the delta wave has likely peaked and is now receding in the US and globally,” JPMorgan said.
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Any dip in the stock market, like last week’s almost 5% Evergrande-induced decline, should be viewed as a buying opportunity for investors, JPMorgan said in a note on Monday.

The bank believes last week’s selling was driven by technical flows from CTAs and option hedgers, and that nothing has fundamentally changed their overall bullish outlook on stocks.

“Any weakness should be used to add to equities,” JPMorgan said, pointing to an expectation that the reopening trade will resume its upward trend as more cyclical sectors drive the market higher. That view is bolstered by an eventual normalization of monetary policy, which should drive interest rates higher, benefiting the sectors.

The Fed is expected to begin tapering its $120 billion in monthly bond purchases later this year, and 75% of market participants anticipate at least one interest rate hike in 2022.

Another important factor that should help boost equity prices is the decline in COVID-19 cases, which JPMorgan believes has already peaked in the US and globally.

“We now think that the delta wave has likely peaked and is now receding in the US and globally. As long as COVID-19 continues to ease, strong growth should reside ahead and activity should be bound to re-accelerate into 2022,” the bank said.

That pick-up in business activity will be driven by a less uncertain view of the global economy in the wake of COVID-19, and as businesses rebuild their depleted inventories and reinvest in their operations.

Finally, JPMorgan expects positive returns for the rest of 2021 as the stock market exits the weakest month of the year and heads into some of the strongest, based on historical data.

COVID-19 cases
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The sell-off sparked by the Evergrande crisis has shaken retail investors’ buy-the-dip mentality, JPMorgan says

NYSE Trader
A trader works on the floor at the New York Stock Exchange (NYSE) in New York City, New York, U.S., March 3, 2020.

  • Retail investors’ confidence in the buy-the-dip trade was jolted after Monday’s stock market sell-off, JPMorgan said in a note.
  • The Evergrande debt crisis sparked $11 billion in outflows from equity ETFs on Monday.
  • “The outflow happened on a down day and is thus inconsistent with the buy-the-dip behavior,” JPMorgan said.
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The Evergrande-induced stock market decline earlier this week jolted confidence in the buy-the-dip trade, JPMorgan said in a note on Wednesday.

The bank highlighted $11 billion in outflows from equity ETFs on Monday, which happened on a day where stocks were down as much as 3%. “The outflow happened on a down day and is thus inconsistent with the buy-the-dip behavior,” JPMorgan said.

Monday’s sharp outflow was one of the largest this year when excluding days with quarter-end option and futures expiry dates, according to the bank. And while momentum traders could have played a significant role in the near 5% stock market correction due to a break-down in certain indicators, retail investors also played a role, JPMorgan said.

Retail investors’ net inflows into equities peaked at around $16 billion in July, before falling to $15 billion in August and declining even further so far in September, JPMorgan said, citing internal research.

“We would need to see more significant inflows into equity ETFs today and the following days to be able to say that retail investors’ impulse into equities and their previous buy-the-dip behavior remains intact,” the note said.

Confidence among retail investors likely surged in recent days given the solid rebound in stocks since Monday’s decline. Despite a decisive breakdown below the technical 50-day moving average earlier in the week, the S&P 500 recaptured that level on Thursday, jumping more than 1%. Now the index is now less than 1% away from reclaiming all of the losses stemming from Monday’s decline.

Equity ETF flows
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The stock market’s fear gauge could signal more weakness ahead if it closes above this key level, according to technical analyst Katie Stockton

NYSE Trader
A trader works on the floor at the New York Stock Exchange (NYSE) in New York City, New York, U.S., March 3, 2020.

The stock market could still have further downside ahead if the Volatility Index closes above the key 25 level for the second day in a row, according to a Tuesday note from technical analyst Katie Stockton of Fairlead Strategies.

Stockton is keeping an eye on the market’s fear gauge as investors assess the damage from a potential default of China’s second largest property developer, Evergrande.

The potential insolvency risk for Evergrande sent the S&P 500 down as much as 3% yesterday after it became clear that the company may be unable to meet its upcoming debt payments of $83 million on Thursday. Now many market participants are wondering if Evergrande’s $300 billion in liabilities could represent a systemic risk to markets.

According to Stockton, the S&P 500’s decisive close below its 50-day moving average on Monday means secondary support at 4,238 is in play, representing potential downside of 3% form current levels.

“The 5% pullback is differentiated negatively from other dips below the 50-day moving average in that the indicators have seen notable deterioration. The daily MACD indicator is in negative territory and the weekly stochastics have fallen from overbought territory, increasing risk of downside follow-through,” Stockton explained.

Monday’s price action is comparable to the March 4 low, in which the S&P 500 fell decisively below its 50-day moving average. But that price action was reversed on March 5, when the S&P 500 jumped back above its rising 50-day moving average.

“Should we see the same from the S&P 500 today, that would indicate that the pullback has matured already. Otherwise, we would brace for a breach of the cloud and test of secondary support,” Stockton said.

Despite Tuesday’s relief rally of about 0.5%, the S&P 500 still remains 1.5% below its 50-day moving average.

Stockton is watching the 25 level on the VIX to sense if more downside is likely.

“We would be concerned if the VIX closes above 25 for two consecutive days because that would hold bearish implications for the inversely correlated S&P 500,” Stockton concluded.

As of Tuesday afternoon, the VIX traded at 23.57 and hit an intraday high of 25.60.

VIX chart
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Markets are awaiting the next major test of Evergrande after default fears triggered a sell-off. Here’s what investors are focused on as key debt payment looms.

Evergrande Chairman
China Evergrande Group Chairman Hui Ka Yan attends a news conference on the property developer’s annual results in Hong Kong, China.

  • The Evergrande debt crisis roiled global markets on Monday as the company’s ability to pay its debts come into focus.
  • All eyes are on Evergrande’s ability to pay $83 million in interest on its bonds due this Thursday.
  • Evergrande already missed interest payments to banks that were due on Monday.
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All eyes are on Evergrande, China’s second largest property developer that is sitting on more than $300 billion in liabilities and may not be able to meet its debt obligations.

The fear of contagion spread from a potential default of Evergrande roiled markets on Monday, with the S&P 500 falling as much as 3%, and the Dow Jones down nearly 1,000 points at its worst level. US stocks rebounded by about 0.50% in initial Tuesday trades.

So what’s next for the embattled company? Interest payments, mostly.

On Thursday, $83 million in interest payments will be due on one of Evergrande’s five-year bond, which had an initial issue size of about $2 billion, according to CNBC citing data from S&P Global Ratings.

Then next Wednesday, September 29, Evergrande will have another interest payment due on a seven-year bond.

Evergrande’s inability to pay the upcoming bond payments would spell more trouble for the company, as it would mean a potential default on several of its US-dollar denominated bonds. That would be worse than the already missed interest payments to multiple banks that were due on Monday, according to Bloomberg.

As of late Tuesday local time, those payments were still outstanding. Some banks are waiting for the developer to propose a potential loan extension plan before they decide whether to declare the cash-strapped developer in default, according to the report.

Even if Evergrande is able to make its upcoming debt payments and already missed bank payments, the crisis will likely remain given that the company has $669 million of coupon payments remaining this year. And of the $88.5 billion that Evergrande borrowed from banks and other financial institutions, nearly half of that is due in less than a year, Bloomberg reported.

Speculation is now mounting that the Chinese government will provide some form of aid to the non-state owned enterprise given its immense pile of debt, uncertainties about the underlying value of its assets, and the large impact the real estate sector has on the Chinese economy.

That aid may be even more likely if Evergrande represents just the first of several property developers experiencing deteriorating financial conditions, meaning a more systemic risk to China’s real estate and financial markets is apparent.

But some believe Evergrande is not too big to fail, including Andrew Left of Citron Research, who first wrote in 2012 why the property developer was on the verge of insolvency.

“I don’t know what happened, but finally this past week, or month, he ran out of friends who are going to refinance his debt, and the debt became way too much,” Left said of Evergrande’s Chairman Hui Ka Yan. “In China, the big talk is, ‘he’s not too big to fail.”

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