Despite earnings consistently surpassing earnings expectations, there have been muted price reactions in stocks, prompting analysts at Morgan Stanley to explore the underlying factors contributing to this apparent discrepancy in a note Monday.
The investment bank stated that unpredictable data and tough rate comparisons are challenging multiples in the near term.
"1Q earnings season has delivered a high beat rate with muted price reactions," said the bank in its note. "We think this is attributable to the pressure on valuations from higher rates, a condition that could remain with us in the near term unless Powell surprises on the dovish side at this week's Fed meeting."
On valuations, the bank further explained that over the past year, the consensus view on the economic outcome has shifted numerous times, which has led to elevated volatility in both front-end and back-end rates. This has near-term implications for equities due to the strong relationship between the six-month rate of change on equity multiples and the 10-year yield.
"Looking forward through June, easier bond yield comparisons present a headwind to valuation even if rates stay at current levels," the bank stated. "From there, rate headwinds should ease if yields don't accelerate higher over the summer."
There has been a strong aggregate earnings surprise thus far in earnings season. However, price reactions have been more muted. The dynamic is said to be in line with what the bank has seen over the last several quarters, fitting its view that the market continues to be discerning when it comes to operational efficiency and expense discipline.
"Earnings revisions breadth (our preferred measure for monitoring guidance) continues to look strong for select cyclical pockets of the market, including energy, where we remain overweight," added Morgan Stanley.