Earnings Season to Test S&P 500 Rally Breadth
The market is poised to scrutinize first quarter earnings reports for a critical assessment of the ongoing rally, with analysts emphasizing the importance of fundamental factors rather than simply price action. Deutsche Bank’s chief equity strategist, Binky Chadha, highlights this focus, stating that “at the end of the day, it’s about earnings and fundamentals.” The upcoming earnings season, kicking off with JPMorgan (JPM) results on Friday, will provide crucial data regarding the trajectory of corporate America. A broader consensus anticipates year-over-year earnings growth of 3.2% for S&P 500 (^GSPC) companies in the first quarter, according to FactSet data, reflecting an upward trend observed in recent quarters.
Market participants are anticipating that corporate earnings and forward guidance throughout the remainder of the year will signal an improved outlook despite the sustained high interest rate environment. Bank of America US and Canada equity strategist, Ohsung Kwon, notes that recent economic growth data has surprised expectations positively, suggesting that consensus estimates may be overly conservative, particularly during this earnings season. Kwon’s assessment is that “consensus might be too low, especially this earnings season,” indicating an expectation for stronger-than-anticipated results.
The driving force behind the S&P 500’s earnings growth this quarter is heavily concentrated in the top 10 stocks, often referred to as the “Magnificent Seven.” Goldman Sachs’ equity strategy team, led by David Kostin, has identified this dynamic, showing that these companies are projected to experience earnings growth of 32% in the first quarter, while the remaining 490 stocks are expected to show an earnings decline of 4%. Nvidia (NVDA) stands out as a clear leader, with expected earnings growth of 406% compared to the previous year, followed closely by Amazon’s (AMZN) projected 175% growth. Meta (META), Eli Lilly (LLY), Alphabet (GOOGL), Berkshire Hathaway (BRK-A,BRK-B), Microsoft (MSFT), Broadcom (AVGO), JPMorgan Chase (JPM), and Apple (AAPL) round out the top 10. This concentration of growth within a select group of stocks means that the overall earnings picture for the benchmark index is inextricably linked to performance of these major corporations.
Kostin’s research suggests that if these powerhouse companies continue their strong performance, the probability of a “acute catch down” — where stock prices fall in response to slower-than-expected earnings growth — is relatively low. Instead, investors are pinning their hopes on a “catch-up” scenario, where earnings growth among the remaining 490 stocks in the S&P 500 begins to rebound later in the year. Although this trend won’t be the primary driver of earnings growth this quarter, Chadha at Deutsche Bank believes there will be discernible signs of a rotation under the surface, reinforcing the recent market narrative of a growing US economy acting as a tailwind for stocks outside of the technology sector. “With a cyclical uptake, with the pickup in CEO confidence that we’ve seen and talked about, you should start to see much better earnings,” Chadha stated. He further expects to see “much better and more confident guidance” from companies. Importantly, Chadha maintains that he still expects “good earnings” for the megacap growth and technology companies moving forward, but anticipates a moderation in the astronomical earnings growth experienced by some of these firms in 2023.
If this moderated guidance is accompanied by positive signals from the broader market — particularly within sectors like Energy (XLE), Materials (XLB), and Industrials (XLI) — it would “continue to encourage” the rotation observed in markets over the past month, with these cyclical sectors outpacing gains in Technology (XLK) and Communications Services (XLC). Charles Schwab global chief investment strategist Jeffrey Kleintop told Yahoo Finance Live that if first quarter earnings calls indicate a potential rotation in progress, that would be seen as a positive sign for the health of the stock market rally. Kleintop further pointed to the recent uptick in manufacturing activity, which has grown at its fastest pace in the US since 2022, as evidence that analyst expectations for an earnings pickup in economically-sensitive sectors are more than just hopeful. “It’s a second wind for the stock market,” Kleintop noted.
