American companies are sending an important signal this earnings season: that the rally in U.S. stocks may begin to expand beyond technology stocks.
Mentions of “rock bottom” in the results of this period of disclosure, until last week, had increased 56% compared to the previous year, according to Bank of America. In the past, such benchmarks have preceded broad earnings improvements, the bank said.
Importantly, cyclical companies, whose prospects are closely linked to the trajectory of the economy, were heavily represented among the companies that filed reports. If earnings from this group start to improve, it would be a sign of upside for investors concerned about the dominance of technology stocks in a market that has gone from record highs to highs this year.
Expanding growth to groups beyond the technology sector becomes especially important for the rally of indices now that tech megacaps are projected to show a slowdown in earnings growth on average. The results of these giants should begin to be released after the close of business on Tuesday, when Alphabet, which owns Google, will present its report.
“We believe third-quarter earnings for many cyclical companies have bottomed out,” said Joe Gilbert, portfolio manager at Integrity Asset Management. “This does not mean, however, that we are ready to rush out with higher earnings estimates, but it gives us confidence that the environment will not worsen.”
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It’s been a tough time for cyclical sectors, which have had to deal with weak demand and higher inventories after the Federal Reserve raised interest rates to their highest level in decades to curb inflation. With central bank easing and the economy in good shape, the outlook for these companies is improving.
“Businesses have been operating in a weak demand environment for nearly two years due to weakness in the goods and industrial sector,” Bank of America strategists wrote in an Oct. 28 report. “But we see signs that the worst may be behind us.”
Next year, they wrote, “we expect a healthy volume recovery in the industrial and goods sectors that have been pressured by higher rates, which should translate into an increase” in earnings per share.
US manufacturing activity shrank in September for the sixth consecutive month, reflecting weak orders and falling employment. However, on a more promising note, a Dallas Fed manufacturing sector survey suggests the October ISM is likely to rise, writes Chris Collins of Bloomberg Economics.
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To date, the third-quarter earnings season in the industrial and materials sectors has seen year-on-year declines and the number of companies reporting weaker-than-expected results has reached the highest level since 2017, according to Wendy Soong, equity strategy data analyst at Bloomberg Intelligence.
And there are many cyclical risks ahead, such as uncertainty surrounding the US presidential election and questions about the pace of China’s economic recovery.
But there were some positives. 3M, the maker of Post-it notes and Scotch tape, raised the lower end of its 2024 earnings forecast and reported third-quarter earnings that beat analysts’ estimates. Fastenal, which sells industrial and construction supplies, saw sales increase in the quarter, according to Bloomberg Intelligence.
Some companies in the materials sector, which depends on the global commodity cycle, also showed positive results. Strong aluminum prices boosted Alcoa’s quarterly profits.
