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Post: The Tell: Why BlackRock says the stock market’s big summer rally isn’t worth chasing

With U.S. stocks sputtering to start the new week, strategists at the research arm of the world’s largest money manager are weighing in with words of caution.

In a note released on Monday by the BlackRock Investment Institute, they said they expect U.S. company earnings to deteriorate and the Federal Reserve to hike interest rates to a level that will “stall the economic restart,” given persistent inflation that’s likely to settle above pre-COVID levels. They also called the stock market’s rally off the mid-June lows unsustainable.

Equities were slightly higher at midday Monday, taking back modest loses seen after U.S. data that missed forecasts plus unexpected signs of slowing growth in China damped investor sentiment. Financial markets have been shifting back and forth between two narratives — one in which easing inflation and slowing growth give the Fed room to back off aggressive rate hikes, the other in which persistently high price gains coupled with a robust labor market compel policy makers to continue lifting borrowing costs.

July’s downside surprise in the consumer-price index gave equities a boost and helped send the S&P 500

and Nasdaq Composite

to their fourth straight week of gains on Friday. The S&P 500 has surged around 16% from its June low and has retraced more than 50% of its bear-market drop.

Read: Inflation surge cools in July. Should you still play defense with your portfolio?

“We don’t think the equity bounce is worth chasing,” said strategists Wei Li, Beata Harasim and Tara Sharma, along with BlackRock Investment Institute’s Deputy Head Alex Brazier. “We believe the Fed will remain susceptible to ‘the politics of inflation,’ a chorus of voices demanding it tame inflation. Our bottom line: The latest inflation reading isn’t enough to spur the Fed pivot we’ve been waiting for to lean back into stocks.”

What’s more, they said, consumer spending is in the process of shifting toward services and away from goods, the category which benefited from the stay-at-home stage of the pandemic. That shift “could hit stocks,” according to the BlackRock strategists: They note that earnings tied to goods are expected to make up 62% of the S&P 500’s profits this year, versus 38% for services, as shown in the chart below. A boom in services would power the economy more than it would S&P 500 earnings.

Sources: BlackRock Investment Institute, Refinitiv, and U.S. Bureau of Economic Analysis.

“The risk of disappointing earnings is one reason we’re tactically underweight stocks,” they said.

“S&P 500 earnings growth has essentially ground to a halt, we calculate, if you exclude the energy and financial sectors. That’s down from 4% annualized growth last quarter, Bloomberg data show. What’s more, we believe analyst earnings expectations are still too optimistic,” they wrote.

Wall Street strategists are divided over whether the stock rally has continued momentum, with those at JPMorgan Chase & Co. saying it still has legs and rivals at Morgan Stanley predicting share prices will slide in the second half.

As of Monday morning, all three major U.S. stock indexes were lower, though pockets of buyers could be found in S&P 500 value and growth stocks, as well as the utilities, healthcare and consumer staples sectors. New York-based BlackRock managed $8.49 trillion as of June.

Need to Know: Ready to cash out some gains on this stock-market run? An exit path is about to emerge, says this strategist.

Hear from Carl Icahn at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The legendary trader will reveal his view on this year’s wild market ride.

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