Investors in the U.S. stock market should be cautious and prepared for potential challenges, as company earnings face "near-term pressure," warns Wells Fargo Investment Institute.
Earnings on the Decline
Wells Fargo Investment Institute predicts that earnings for all equity classes have reached their peak and are expected to decrease as the economy weakens and revenue growth slows down. The institute expects a downward trend in earnings accompanied by periods of weakness and range trading.
To support their analysis, Wells Fargo studied the historical decline in the S&P 500's earnings per share (EPS) during previous recessions. They found that earnings are likely to be significantly affected, with the median peak-to-trough drop being 21.4%.
Anticipated Challenges Ahead
Wells Fargo also highlights that a slowing economy, along with tighter financial and credit conditions, will create headwinds for investors in the future. These factors contribute to the institute's recommendation for a defensive investment approach.
Recent market performance portrays mixed signals. The S&P 500 achieved its second record close of 2024 on Monday, following its all-time closing high on January 19th after a two-year gap. Meanwhile, on Tuesday, U.S. stocks experienced varying trends: the S&P 500 gained 0.2%, the Nasdaq Composite was up 0.2%, and the Dow Jones Industrial Average was trading 0.3% lower.
It's crucial to remain cautious amidst these market fluctuations, as potential risks and uncertainties persist.
Read: Beware of 'pricey' U.S. stocks as inflation may 'roller-coaster back up,' warns BlackRock
Companies Release Fourth Quarter Earnings Reports
Several companies, including Verizon Communications Inc., General Electric Co., and Procter & Gamble Co., shared their quarterly results on Tuesday. Investors are now waiting for Netflix Inc. to announce their earnings after the closing bell on the same day.
U.S. Stock Market Strength Attributed to Multiple Factors
The recent strength observed in the U.S. stock market can be largely attributed to a combination of aggressive rate cuts, a resilient economy, low inflation, and favorable financial and credit conditions, according to Wells Fargo. These factors rarely align together.
Upcoming Economic Data and Analyst Recommendations
Investors can expect to see a preliminary reading on the U.S. gross domestic product (GDP) for the fourth quarter on Thursday. Additionally, the Federal Reserve will release a fresh report on inflation using its preferred inflation gauge, specifically core data from the personal-consumption-expenditures price index, on Friday.
In terms of stock recommendations, Wells Fargo is favoring U.S. large-cap stocks, maintaining a neutral stance on U.S. midcap equities, and expressing the most caution towards U.S. small-cap stocks.
Positioning for an Emerging Early Cycle Recovery
Wells Fargo anticipates an economic slowdown to be fully priced into market valuations. Once this occurs, they will seek an opportunity to position themselves for an emerging early cycle recovery. The firm believes that more cyclical equities will benefit the most when the economy regains stability and corporate earnings start to grow again.