‘Moment of Truth’ Arrives for U.S. Stocks After Fed-Fueled Rally

It’s “gut check” time for U.S. equity investors as the pivot from a Fed-fueled rally back to the foggy fundamentals looms, according to Morgan Stanley.

“The moment of truth may be arriving with first-quarter earnings results,’’ Michael Wilson, the bank’s chief U.S. equity strategist, wrote in a note Monday. He said that this year’s stock rally can be entirely attributed to investors pushing up company valuations amid the U.S. central bank’s dovish turn, and the profit reports could mark a turning point.

The reporting season begins in earnest with JPMorgan Chase & Co. and Wells Fargo & Co. on Friday.

Corporate executives might find themselves in a difficult position. While reporting an expected 4 percent drop in earnings per share from a year earlier, they’ll have to either convince investors that the worst performance is in the rear-view mirror or temper expectations for a second-half — and in particular, fourth-quarter — comeback. Tech is projected to be the largest drag on first-quarter results; without the sector, the shrinkage in profits is a more modest 2.8 percent.

It’s unclear which would be preferable to investors: higher conviction in the outlook or a lowered, but more realistic, bar for future quarters, Wilson wrote. Indeed, half of the past four reporting periods have seen investors relatively unmoved by strong showings, with concern about the potential for a deceleration in economic activity rising to the fore.