Rebound in U.S. stocks faces earnings test

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By Caroline Valetkevitch

NEW YORK (Reuters) - A tentative bounce in U.S. stocks is about to face a key test, as companies get set to report fourth-quarter results amid worries over a potential recession in 2023.

Analysts expect earnings for S&P 500 companies to have declined 2.2% for the quarter compared with a year ago, according to IBES data from Refinitiv as of Friday.

That would be the first U.S. quarterly earnings decline since the third quarter of 2020, when companies were still grappling with the start of the coronavirus pandemic.

Results from some of Wall Street's biggest banks are expected to kick off the reporting period on Friday.

Despite the recent gains in stocks, "most people are taking a wait-and-see approach to see how the first week or two of reports come out and what type of guidance we get," said Michael O'Rourke, chief market strategist at JonesTrading in Stamford, Connecticut.

The S&P 500 is up about 3.8% so far in 2023 after falling more than 19% last year, its biggest annual decline since 2008. Investors remain focused on whether the Federal Reserve's aggressive monetary policy tightening to control inflation could push the economy into recession.

Some strategists are hopeful that U.S. companies may be able to handily beat fourth-quarter estimates, which have fallen sharply since October, and that results may be supportive for stocks in the coming weeks. Also, they say, earnings weakness may already be priced into the market.

Concerns remain about expected sharp year-over-year drops in earnings for the heavily weighted S&P 500 technology and communication services sectors, which had for years been a source of profit and market strength.

"That reliance on growth and technology and momentum, that might be the comeuppance with fourth-quarter earnings news," said John Lynch, chief investment officer for Comerica (NYSE:CMA) Wealth Management in Charlotte, North Carolina.

"That could be the catalyst to get us back down."

The technology sector was down 29% last year, while communications services fell 40%. Rising Treasury yields have pressured shares of tech and growth companies especially hard.

Hopes that inflation may be slowing and that the Fed could soon ease back on its aggressive tightening have boosted the market in recent sessions.

U.S consumer prices unexpectedly fell for the first time in more than 2-1/2 years in December amid declining prices for gasoline and other goods, data showed on Thursday, suggesting that inflation was now on a sustained downward trend.

Investors will be closely watching for further signs that higher costs are squeezing profit margins.

Lululemon Athletica (NASDAQ:LULU) Inc this week forecast a decline in holiday-quarter gross margins as the retailer deals with higher costs.

Still, Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities in New York, and other strategists have noted that company pricing power is based on inflation, and that has benefited sales growth.

Jake Dollarhide, chief executive officer of Longbow Asset Management in Tulsa, said a theme in company conference calls with analysts may be cost-cuts, given recent announcements from companies.

Goldman Sachs (NYSE:GS) began laying off staff on Wednesday in a sweeping cost-cutting drive, a source familiar with the matter said.

"There's risk to outlooks for a lot of companies because the environment is deteriorating because interest rates are up," said Tim Ghriskey, senior portfolio strategist at Ingalls & Snyder in New York, New York.

Fourth-quarter results also are up against tough comparisons with the year-ago quarter, when S&P 500 earnings grew 32.1%, based on Refinitiv data.

Some see reasons to be optimistic going into earnings. "There's just been too much pessimism in the marketplace, and it will surprise to the upside if we see good numbers," said Gary Bradshaw, portfolio manager at Hodges Capital Management in Dallas.

Analysts expect S&P 500 technology sector earnings to have dropped 8.7% in the fourth quarter from a year earlier, while they see communication services sector earnings falling 21.4%, per Refinitiv data.

Overall, seven of the 11 major S&P 500 sectors are expected to show a decline in year-over-year fourth-quarter earnings, based on the data.