The current stock market rally is not sustainable as earnings deteriorate and Fed rate hikes stall economy, BlackRock says

• The current stock market rally from its mid-June low is unsustainable, according to BlackRock.
• The asset management firm told clients that the rally in stocks would be derailed by deteriorating earnings and more Fed rate hikes.
• "We see the Fed hiking rates to levels that will stall the economic restart," BlackRock said.

BlackRock is sticking with its recommendation for investors to be underweight in stocks, calling the current rally unsustainable due to deteriorating corporate earnings and continued interest rate hikes from the Federal Reserve.

The S&P 500 has surged about 18% from its mid-June low, while the Nasdaq 100 has jumped more than 20% as inflation showed signs of cooling and the Fed signaled that future interest rate hikes could be smaller than its recent 75 basis point hikes.

But investors shouldn't be too hopeful that the worst of the stock market decline is over, according to BlackRock.

"Stocks jumped on hopes of the Fed pausing hikes soon as inflation edges lower. We think that's premature and see inflation settling above pre-Covid levels," BlackRock said.

In inflation remains elevated, then more interest rate hikes from the Fed are likely. Additionally, corporate earnings could come to focus as consumers shift their spend away from goods and towards services.

"We see the Fed hiking rates to levels that will stall the economic restart. Corporate earnings may weaken more as consumer spending shifts and profit margins contract," BlackRock said.

Second-quarter earnings have proved resilient, but the current makeup of the economy relative to the stock market means going forward, earnings results could weigh on stock prices, according to BlackRock.

That's because consumer spending is shifting away from goods and toward services, and S&P 500 earnings are mostly made up of goods companies.

"Earnings tied to goods are expected to make up 62% of S&P 500 profits this year, versus 38% tied to services. In addition, the stock market isn't the economy. Goods accounted for less than a third of the US economy in the first half of this year. This means a boom in services doesn't power S&P 500 earnings as much as it does the economy," BlackRock explained.

Meanwhile, overall spending could be poised for a decline, as BlackRock believes that US economic activity is set to contract as the country navigates production and labor supply constraints.

Ultimately, BlackRock calculated that S&P 500 earnings growth has "ground to a halt" when energy and financial sectors are excluded, down from 4% annualized growth just last quarter.

"We're not chasing the rally. Why? First, market expectations for a dovish [Fed] pivot are premature. We think a pivot will come later as the Fed is for now responding to pressure to tame inflation. Second, we see the market's views on earnings as overly optimistic," BlackRock concluded.