Strong Corporate Earnings Differentiate Current Market From Past Sell-Offs, RBC Says

The U.S. stock market's recent resilience is largely due to strong corporate profitability and rising earnings forecasts, factors that distinguish the current environment from previous major market sell-offs, according to a new analysis from RBC Capital Markets.

Historical Context of Market Drawdowns

RBC's head of U.S. equity strategy, Lori Calvasina, reviewed every S&P 500 decline of 11% or more from a record high since 1956. The research identified several recurring triggers for these significant drawdowns, including looming recessions, rising interest rates, stretched valuations, geopolitical shocks, and sharp swings in oil prices.

The most severe periods of market stress shared common fundamental weaknesses. According to the analysis, these downturns were consistently marked by falling corporate profit growth, downward revisions to earnings forecasts, contracting valuations, sharp drops in sentiment, and an increase in layoffs, alongside weakening economic growth and manufacturing activity.

How the Current Environment Differs

In contrast to those historical precedents, current conditions present a more robust picture, Calvasina noted. The key differentiators supporting today's market include:

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• Corporate profitability is on an upswing.
• Earnings forecasts are still being revised to the upside by analysts.
• Manufacturing and industrial production appear to be in the early stages of a recovery.

RBC also observed that consumer confidence has already experienced a significant decline and investor sentiment is well below its peak levels, suggesting that a degree of pessimism may already be priced into the market.

Risks and Outlook

Despite the current strengths, RBC warns that these positive indicators could weaken. The primary risks cited are the Federal Reserve's monetary policy and climbing bond yields, which could pressure the economy and corporate profits, potentially leading to a deeper decline than the 5% to 10% pullback RBC has been anticipating.

Calvasina's report included a new stress test scenario that considers higher inflation, additional Fed rate hikes, and a rise in the 10-year Treasury yield. For now, however, the market's positive fundamentals are holding firm. "But for now, the stock market is taking an innocent until proven guilty approach," Calvasina wrote.