US Equities – Corporate Profits Already Hitting New Highs
What happened last week?
The S&P 500 and Dow gained 0.24%, 0.94% while the Nasdaq fell and -0.92% on the heels of a nearly complete profits reporting season that saw S&P 500 2Q24 EPS up 14.0% y/y.
In August, every S&P 500 sector posted gains except for the Energy and Consumer Discretionary sectors.
On Friday, the Fed’s favorite inflation gauge, the Core Personal Consumption Expenditure (PCE) deflator, came in at 2.6% y/y, to help smooth the glidepath for the Fed to lower rates starting on September 18.
3 Things to Know
EPS Gains Broadening in 2024
As is custom in all but the deepest earnings downturns, with the help of analysts, US firms had no problem exceeding estimates when they reported second quarter results this summer.
But despite an average beat of over 5%, markets sold off during the busiest two weeks of the earnings season as many firms moderated guidance for the second half of 2024.
After significant downward revisions to 3Q, we see the bar as sufficiently lowered to continue the tradition of broad earnings beats next quarter. Consensus estimates for 2025 at 14.4% remain higher than our new estimates, but this is typical when looking at analyst estimates beyond a quarter ahead.
We have been on the “broadening train” all year for two reasons. First, we viewed excessive index concentration as a risk for investors who seek truly diversified exposure to public markets. Indeed, the Magnificent 7 concentration peaked at 31.5% of S&P 500 market cap in mid-July after strong outperformance throughout Q2. We’ve discussed in previous bulletins the perils of portfolio concentration (please see our June 22nd CIO Bulletin).
Second quarter earnings season reminded investors that mega cap tech is not invincible. Ongoing AI-related capex has far outpaced big tech revenues, and after six quarters of significant AI spending ramp-up, some investors are growing impatient about the eventual fruits of this investment. Four of the Magnificent 7 sold off following their 2Q earnings results.
Raising 2024 & 2025 EPS Estimates
Following the bulk of 2Q EPS reports, we are making slight upward revisions to our S&P 500 EPS estimates for both 2024 and 2025. We now see S&P 500 EPS rising about 9% in 2024 and 8% in 2025 vs 8% and 6% previously.
The good news? We believe today’s record high EPS levels will be exceeded in the coming quarters. The bad news, our estimate increases are modest. The overall pace of EPS gains in 1H (just below 10%) is unusually strong for a period off Fed easing, but not historically rapid.
Corporate Profits Expected to Produce New Highs in the Coming Years
Another driving force for our broadening call was our expectation for a wider range of companies to deliver positive earnings growth in 2024 and 2025, a dynamic which we see playing out in recent results.
This has enabled the equal- weight S&P 500 to reach a new all-time high this week even while tech remains off its own peak. While a 10% return in the average S&P 500 stock has not kept pace with tech year-to-date, our overweight has outpaced performance of broad bond indices where we remain underweight.
As we continue to make new highs for profits into 2025, a nascent earnings recovery will also likely be playing out among smaller firms. While small- and mid-cap companies have seen their profits lag in 2023 and 2024, falling financing costs and a less tech-dependent earnings backdrop should be supportive for SMID profitability next year.
Within the profitable SMID universe, firms tend to operate with more debt and higher usage of floating rate bank financing. As the Fed cuts rates through 2025, earnings-after-interest costs for small firms should improve.
See our weekly CIO Strategy Bulletin for more details