U.S. companies will need to deliver the biggest profit increase in more than two years to avoid disappointing Wall Street's bullish analysts, challenging further gains in stock markets after a string of records.
S&P 500 stocks are expected this month to report year-over-year earnings growth of nearly 9% in the three months through June, the biggest quarterly increase since early 2022, according to analyst forecasts compiled by FactSet.
The index climbed about 16% in 2024, in a rally driven mostly by a handful of big tech companies.
That has pushed stock market valuations to their highest level in nearly three years, leaving room for disappointment if earnings fail to live up to expectations.
We need earnings to catch up with valuations [are]said Liz Ann Sonders, chief investment strategist at Charles Schwab. I'm not saying it's going to be a disappointing quarter where you don't meet those expectations, but clearly the bar has been set pretty high.
Investment banks including JPMorgan Chase and Citigroup kicked off the season on Friday, July 12, with financials leading the way in the early days. Microsoft, Google parent Alphabet and Tesla are set to report results on July 23.
Analysts typically cut their corporate profit forecasts as earnings season approaches, but this quarter the trend wasn’t as steep. The numbers were cut by just 0.5%, compared with an average of 3.4% over the past five years, according to FactSet.
At the same time, the tech rally has propelled the S&P to a record high and pushed its valuation from 19 times expected earnings in January to a multiple of just over 21 times its highest level since late 2021, during the coronavirus pandemic.
These gains were largely driven by five giants, Nvidia, Apple, Microsoft, Amazon and Meta, whose price-to-earnings ratios have risen much faster, reaching an average of 34 times forecasts, up from 28 times in January. Nvidia’s price-to-earnings ratio rose to 41 times from 24 times in January, driven by higher expectations for demand for chips linked to artificial intelligence.
However, Deutsche Bank forecasts that Big Tech earnings growth will slow to an average of 30% year-on-year in the three months to June, from 38% in the previous quarter.
Analysts instead expect rising profits from other U.S. companies to support any further market gains. But some say the importance of tech giants means even better-than-expected earnings from a household name in another sector may not be enough to offset the market impact of Big Tech's daily moves.
Market sentiment is such that it is not clear to me that good results, from say Pfizer, Johnson & Johnson or Walmart, can outweigh a good or bad day. [of share price performance] for Nvidia and Microsoft, said Steven Sosnick, chief market strategist at Interactive Brokers.
Our prices may not be perfect, but they are really, really good, he added.
Binky Chadha, head of U.S. and global equity strategy at Deutsche Bank, said he expected stronger earnings from energy and materials companies to offset slowing tech earnings growth, but said the potential for a summer stock market rally was limited.
“At current levels and with fairly robust valuations, earnings growth is priced in. We expect earnings to be good, but I don’t necessarily think they would be a positive catalyst,” Chadha said.
A Goldman Sachs study found that historically, growth stocks with higher valuations have underperformed the market by 32 percentage points, missing forecasts twice as much as stocks trading on lower multiples.
Looking ahead, we expect valuations to remain broadly unchanged and earnings growth to instead lift the S&P 500… to a new high of 5,600 by year-end, the bank told clients in a recent note.
