Transcript
Amada Agati:
Grab your popcorn and settle in for a sneak preview of the market’s latest coming attraction — fourth quarter earnings! Will it be an edge-of-your seat thriller or a total snooze-fest? We’re not quite a quarter of the way through, and so far, we give it a “brilliantly boring” rating for being right in-line with expectations. In this month’s edition of Adding Alpha, we’re giving our review of earnings season and gauging how it sets the stage for what to expect in 2025.
With only about 20% of S&P 500 companies having reported, we believe fourth quarter earnings season is shaping up to be representative of what investors should expect to see throughout the year: earnings growth and profit margin expansion among more sectors beyond just mega-cap tech, as well as increased market breadth.
Intra-quarter revisions have been about in-line with their 3-year average, and so far, it looks like this will be the fifth consecutive quarter of positive earnings growth since the earnings recession ended in third quarter 2023. It’s still early, but we’re giving this season a solid four-star rating, with the blended growth rate tracking at 12% year over year. Topline growth is also coming in strong at 4.6%, with eight out of 11 sectors contributing.
The S&P 500 index-level profit margin is about 200 basis points off the peak of this cycle, but profit margins may finally be set to stage a comeback. Input costs are still elevated, though we’re in a much better place this year relative to last year as inflation trends stabilize.
Indeed, top- and bottom-line growth and a strong earnings upside surprise of more than 700 bps is just what we want to see. However, if we pull back the curtain, earnings growth is still somewhat concentrated. Last year was all about the “Magnificent 7” stocks, which drove both earnings AND market returns. If you remove just those seven tickers from the S&P 500, that 12% growth rate for the fourth quarter drops to 9%, as the chart shows!
We’re keeping close watch on sectors such as Industrials and Energy that had negative earnings growth in 2024. If they rebound like we expect, then it means earnings growth is broadening out, which should create more of a distinction between winners and losers based on fundamentals, rather than mega-cap tech stocks vs. everything else.
From a leadership standpoint, growth stocks are still expected to be in pole position. However, we are seeing a rotation away from Tech and Communication Services and instead, toward Health Care, Energy, Industrials and Financials as these sectors are much more correlated with the path of U.S. GDP growth, which is tracking at a solid 2%+ for 2025. In addition, if we start to see a manufacturing rebound later in 2025, it should also bring about a much-needed boost in capex spending — yet another potential catalyst for a sustainable rotation in market leadership.
All in, consensus expects 9% earnings growth for the S&P 500 in 2024 and 15% in 2025. While it may be tempting to extrapolate this as an indicator of strong expected price performance in 2025, it’s worth noting that global equities delivered strong returns in 2023 and 2024 due almost entirely to forward P/E multiple expansion.
The 10 largest stocks in the S&P 500 are trading at a forward P/E of 34.7x versus 20.2x for the rest of the index – a huge disparity and differential and we think it’s likely to become the key governor in terms of the market’s ability to advance in 2025.
