The U.S. stock market continued to show resilience Wednesday, despite a series of disappointing earnings reports, reflecting investor faith in the Federal Reserve and the Chinese government to engineer a rebound in global economic growth, analysts told MarketWatch.
“If we’re looking at third-quarter earnings in a vacuum, it would be very difficult to say that they are better than feared,” Yousef Abasi, director of U.S. institutional equities at INTL FCStone told MarketWatch, pointing out that at the end of September, estimates for third-quarter earnings growth for S&P 500 index SPX, +0.28% companies were for a 3% contraction, and that projection has fallen to minus 4.7% today, according to FactSet.
On Wednesday, the The Dow Jones Industrial Average DJIA, +0.17% rose 0.2%, the S&P 500 index added 0.3% and the Nasdaq Composite Index COMP, +0.19%, added 0.2%.
Despite the worsening earnings picture, the S&P 500 has risen nearly 0.9% in October, and even individual companies that have posted disappointing results have seen their stocks gain in value.
Take for instance Caterpillar Inc. CAT, +1.23%, which on Wednesday reported a third-quarter profits and revenue that fell from a year ago, more than analysts had predicted, but saw its stock rise 1.2%. Shares of Boeing Co. BA, +1.04% also rose, gaining 1%, despite reporting earnings that fell below Wall Street forecasts, though it did bring in more revenue than expected.
One reason for Caterpillar’s rise are encouraging signs of stabilizing sales growth. “For all the doom and gloom surrounding the company’s earnings report this morning, we would note that the two percentage-point improvement in machinery sales in September was the biggest month over month increase since April 2018,” analysts from Bespoke Investment Group wrote in a Wednesday note. They also pointed out that while sales in Asia are still declining, the rate of contraction has slowed, perhaps indicating that the global industrial sector has found a bottom.
J.P. Morgan analysts Ann Duigan told Bloomberg News that “China does seem to be getting a little bit better” arguing that with Caterpillar stock trading below its historic price-to-earnings multiple “this is the time that investors want to buy Caterpillar,” in preparation for a turnaround.
Michael Arone, chief market strategist at State Street Global Advisors said that the current earnings period is particularly interesting because of the diverging performances of companies based on their geographic revenue sources and industries. “It’s feast or famine between sectors and industries within sectors,: he said, pointing out that companies that generate more income abroad are struggling mightily while those that generate a large share of revenue within the U.S. are performing much better.
Indeed, the struggles of the semiconductor sector — which derives a significant share of demand from outside the U.S. — appear to counter the notion that global economic growth is set to improve. Shares of chip maker Texas Instruments Inc. TXN, -7.48% fell 7.5% Wednesday after it reported profits and sales that fell more sharply than predicted, while lowering its outlook for the fourth quarter.
Given the picture painted by such outlook revisions, Arone said that he believes the market is being too optimistic on the topic of U.S.-China trade. “What’s being priced into the market is a resolution of the U.S. China trade conflict, but what’s being reflected in the results are the ongoing challenges of the conflict,” he said. “Investors have been looking beyond the trade conflict as it relates to earnings because they think there will be a full resolution. I think that’s being overoptimistic,” he said.
Another reason for the market’s resilience is the Federal Reserve.
“The real driver is that the Fed’s support of the stock market is back,” INTL FCStone’s Abbasi said, pointing out that expectations are very high that the central bank will lower interest rates for the third time in many meetings when its interest-rate setting committee gathers next week. Fed funds futures markets are placing a 93.5% probabillty that the Fed lowers rates Oct. 31, according to CME Group.
Meanwhile, the Fed has once again begun expanding its balance sheet in order to meet demand for bank reserves. While Fed officials have stressed this move is geared toward improving liquidity in the banking system rather than easing financial conditions, Abbasi said the $60 billion per month the Fed is buying in government debt to create those reserves is stimulative and is helping to steepen the yield curve, which is giving investors confidence that economic growth will accelerate.
“For two or three weeks in September, I tried to fight it and be more bearish, but watching the tape it became very difficult,” Abbasi said. “The Fed’s actions and the steepening of the yield curve is driving confidence.”