Best month for stocks now faces off with Fed, inflation catch

Actually, it’s so good that it has been the best month for the S&P 500 for the past 25 years. And hopes are high that after a first quarter to forget, this April too will be a strong one even as US companies start to report the effect of decades-high inflation on their profit margins.

“This earnings season is going to be very important,” said Ryan Detrick, chief market strategist at LPL Financial. “There has been so much negativity that the bar has been lowered. If corporate America continues to see a healthy economy with a strong consumer, that’s going to help the stock market.”

The first quarter season will kick off on April 13, with JPMorgan Chase & Co. among the first of the big banks set to deliver results. There are many headwinds: In addition to the war in Europe, Friday’s jobs and inflation data reinforced the argument for aggressive Federal Reserve tightening. But stocks have bounced in the last two weeks of March, supported in part by improving expectations for first-quarter earnings for S&P 500 companies.

Analysts forecast growth of about 5.7% in earnings-per-share for the first three months of the year, boosted by the quarter’s large commodity-price gains but dragged lower by tough comparisons for the financial sector, data from Bloomberg Intelligence show.

“Forecasts for S&P 500 EPS growth have risen for all four quarters of 2022, throwing cold water on theories that high inflation and rising interest rates will degrade the outlook,” BI chief equity strategist Gina Martin Adams and senior associate analyst Wendy Soong wrote in a research note. And while “revisions are narrow and margins may remain problematic, particularly for consumer sectors, our guidance-based model suggests the consensus for 1Q may still be too low.”

Safe havens

To be sure, S&P 500 sectors perceived as safer, such as utilities and real estate, have been outperforming the broader market, raising questions about the durability of the latest leg up in stocks. Investors, hungry for yield, have poured money into these corners of the market that typically rise during difficult times and in some cases pay high dividends.

Big Tech stocks have also rebounded in recent weeks, with the Nasdaq 100 Index rising 10% since Russia’s invasion of Ukraine in late February. Many growth stocks were pummeled as higher borrowing costs threaten to pressure growth stocks, whose valuations are based on future profit growth. Now money managers are eager to hear how those companies are faring.

“This will be a tough reporting period,” said Ron Saba, senior portfolio manager at Horizon Investments. “We’re just coming out of Covid, and there are still uncertainties with supply chains and manufacturing. Now add on the global uncertainty caused by Russia. It will be fascinating to hear how management teams are dealing with all of this.”

Midterm twist

April has had a long history of delivering stellar gains to investors. Since 1997, the S&P 500 has averaged a return of 2.5% in April, according to data compiled by Bloomberg. Separate data from LPL Financial show this month is the best on average going back as far as 1950.

But there’s a catch this year: midterm elections. The stock market tends to struggle early in midterm election years due to the uncertainty of the outcome and the potential for policy changes in Washington. In fact, the second quarter is the weakest of the four-year presidential term, dropping 2.1% on average since 1950, data from LPL Financial show.

Still, for some strategists such as Detrick at LPL, the latest rally may not be over following weeks of elevated pessimism, with April once again bringing positive returns for investors.

“We wouldn’t be surprised at all to see strength again in April despite what’s normally a seasonally weak time in midterm years,” he said. “After the S&P 500 came off its recent low, that could be the market’s way of saying it sees a better economy later this year, which is not what most people are expecting right now.”