Key watchpoints for U.S. Q4 earnings season

Executive summary:

  • We believe U.S. recession risks remain for 2024
  • Commentary from company management will be a key focus during U.S. Q4 earnings season
  • More China stimulus is possible this year

On the latest edition of Market Week in Review, Investment Strategy Analyst BeiChen Lin and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, recapped market performance in 2023 and assessed U.S. recession risks for 2024. They also previewed what to expect during U.S. fourth-quarter earnings season and chatted about recent economic data releases from China.

What sparked 2023's year-end market rally?

Antal-Gilbert and Lin kicked off the segment by noting that despite all the gloomy projections at the start of last year, markets fared pretty well in 2023, with the benchmark U.S. S&P 500® Index ending the year up nearly 25%. "That's a solid and healthy rate of return for investors," Lin noted, adding that some of the rally can be attributed to the belief that the U.S. Federal Reserve (Fed)'s aggressive rate-tightening cycle might finally be over. He explained that Fed Chair Jerome Powell gave credence to this idea last month by noting that rates are likely at or near peak levels for the cycle.

Bolstered by the idea that the U.S. economy may be headed toward a soft-landing—where economic growth slows but a recession is avoided—markets rose higher in the final months of the year, Lin noted. However, he cautioned that recession risks still remain elevated.

"Think about it this way: When you near the end of a tunnel and see light up ahead, you want to make sure it's sunlight you're seeing—and not the headlights of an oncoming train. In other words, there are still various economic risks looming out there that could push the U.S. economy in a different direction," Lin explained. These include an increase in the unemployment rate or a decline in corporate earnings, either of which could lead to reduced consumer spending, he said.

Ultimately, Lin said that while he doesn't see a U.S. recession as necessarily inevitable, he believes it's also too early to completely discount the risk. Given the uncertain economic backdrop, Lin emphasized that it's important for investors to remain cautious and disciplined in the months ahead.

Company management remarks likely to be a key focus during earnings season

Shifting to U.S. fourth-quarter earnings season, Antal-Gilbert asked Lin what investors should be paying attention to as the season kicks into gear in the next few weeks. Noting that most estimates call for low-to-mid single-digit earnings growth on a year-over-year basis, Lin said one watchpoint will be how many S&P 500 companies beat these expectations—and whether these beats are concentrated in one sector or spread out. "Over the last few quarters, we've seen a trend emerge of companies beating analysts' initial growth estimates, so we'll be watching this closely," he remarked.

Another focus of Lin's during earnings season will be what company management says about hiring intentions in the months ahead. "The key to a soft landing is that we want the labor market to slow down, but not slow down too much—so any information around planned hiring or layoffs will be important," Lin explained.

He said he'll also be paying attention to guidance from management on dealing with corporate financing costs, given that interest rates are at pretty restrictive levels. With the Fed's overnight rate at a 22-year high of 5.25%-5.5%, companies will have a more challenging time financing their operations, Lin remarked.

Last but not least, Lin said he anticipates the divergence between U.S. large cap and U.S. small cap companies to be a key watchpoint for investors during fourth-quarter earnings season. He explained that while earnings growth for large cap U.S. companies is expected to be positive, growth for U.S. small cap companies is expected to decline by around 10% on a year-over-year basis, as small companies often have a harder time adapting to higher interest rates.

"Overall, it will be very interesting to see what company management says about how they plan on responding to the current economic and operational challenges. I expect these answers will give us a better sense of whether the U.S. is heading for a soft landing or a recession," Lin concluded.

Is more China stimulus likely this year?

Antal-Gilbert and Lin wrapped up the conversation with a look at the latest economic data releases from China. Lin said that the recent releases are a mixed bag, with China's official manufacturing PMI (purchasing managers' index) dipping to a level of 49.0 in December. Conversely, the Caixin manufacturing PMI for China rose to a level of 50.8 last month, he noted. Readings above 50 point to expansionary conditions, while readings below 50 point to contractionary conditions, Lin explained.

"These readings imply that China will remain focused on growth in the year ahead. While the government likely wants to ensure it achieves a decent amount of economic growth in 2024, it also doesn't want to overleverage the economy," he stated, explaining this is why China has so far been careful with the stimulus it's provided.

Lin said that although the government hasn't announced an official growth target for 2024 yet, there are some indications it might set a target of around 5% again. However, he believes that in order for that to be met, Chinese leaders will need to inject more stimulus into the economy. "I don't think this necessarily has to be a massive amount, but I do think it needs to be meaningful enough to get China's economy back on track," Lin opined. He concluded by stressing that despite some concerns over the health of the world's second-largest economy, investors would be best-served by staying calm and disciplined on China as the year unfolds.

Watch the videoListen to the podcast