The stock market’s rally is running out of steam and the S&P 500 could enter correction as what is shaping up to be a brutal earnings season kicks into high gear, according to one Wall Street strategist.
With 41 companies, or 14 percent of the S&P 500, having already reported, Wall Street analysts are ratcheting down their forecasts and now expect a 15 percent year-over-year drop in earnings per share.
The ratio of companies guiding above consensus versus below consensus is 0.3x, the lowest since March 2009, according to Bank of America. Eighty companies have already suspended their outlooks due to uncertainty caused by COVID-19.
“With many risk assets now overbought, we would not be surprised if a correction in US equities begins soon," wrote Mike Wilson, chief U.S. equity strategist at Morgan Stanley. A correction is defined as a 10 percent drop from the recent peak.
The S&P 500 has rallied 28 percent off its March 23 low, closing at a six-week high of 2,874 on Friday, as investors have looked ahead of the reopening of the U.S. economy, which has been brought to a near standstill as “stay-at-home” have caused companies to temporarily close their doors and furlough workers.
However, Wilson says the index is likely to run into a wall of resistance at 2,995, which is home to the 50-week moving average.
“Keep in mind that the highest quality companies tend to have the highest expectations which makes their stocks potentially more vulnerable to the bad micro news we expect from most companies,” he wrote.
Results through the first week of earnings season were “better than average on sales but worse on earnings,” wrote Savita Subramanian, equity and quant strategist at Bank of America. She says expectations are for sales to grow by 1 percent and that margin expectations have been cut by 100 basis points to 9.6 percent.
The firm’s Corporate Misery Indicator, a macro gauge based on unit sales, pricing and costs, which fell in the first quarter after rising in the final three months of last year, often leads profits and “does not bode well,” Subramanian wrote.
The uncertain business environment has so far caused 20 S&P 500 companies to cut their dividends and 60 to suspend share buybacks. Shares of the companies that have taken those measures have underperformed by 9 percentage points and 6 percentage points, respectively, in the week following the announcement, Bank of America said.
Wilson says the 200-week moving average will provide strong support for the S&P 500 near 2,650.
“Our overarching view continues to be that the equity market bottomed in March on what amounted to be a forced liquidation,” Wilson wrote, adding that it is “unlikely we will approach such levels again anytime soon.”