US Stock Market Faces Reality Check in High-Bar Earning Season

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(Bloomberg) — The strongest U.S. stock market rally in two years since the dot-com bubble is headed for the next big test as companies begin releasing quarterly earnings, providing a major internal check on whether valuations have outpaced fundamental reality.

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On Friday, the S&P 500 fell 1.5% — its worst decline since mid-December — as an unexpected surge in hiring fueled speculation that the Fed won’t cut interest rates again until the second half of the year.

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But the bigger problem is the high bar set by investor estimates: Reports are expected to show that a resilient economy led to corporate profits in the Standard & Poor’s 500 index increasing 7.3% during the fourth quarter from a year earlier, according to compiled data. By Bloomberg Intelligence. That’s the second-highest preseason forecast in the past three years, and threatens to put stocks on shaky footing if results — or expectations for the coming months — come in lower than expected.

With the S&P 500 pricing in earnings-per-share growth of roughly 23% in the next 12 months, the estimates embedded in stock prices are unusually high, BI data show. The bottom-up consensus forecast — a method of forecasting a stock’s future performance by adding up individual analyst estimates for each S&P 500 company — calls for earnings per share growth of 13% in 2025, which means these forecasts will need Almost doubled to justify the place of the S&P. 500 deals.

“We haven’t seen a hurdle this high since 2018,” said Michael Kasper, chief equity strategist at BI. “It will be much more difficult for companies to continue to beat earnings estimates this year than in 2024, because the benchmark was much lower then.”

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Fourth-quarter earnings season officially begins on Wednesday, led by leading financial companies like JPMorgan Chase & Co. and Citigroup Inc. and BlackRock Inc. More major companies will report results the following week, including Netflix Inc. and Procter & Gamble Co. And 3M company

Here’s a look at five key themes to watch as the results roll in:

Expansion of growth

One closely watched issue is whether earnings growth momentum will accelerate beyond big tech companies, which could provide a boost to some of the market’s laggards.

With the good economic performance, companies outside Big Tech are expected to report earnings growth for the third straight quarter, with profits expected to rise 4% and accelerate toward double-digit increases by the first three months of 2025, according to data compiled by BP.

Technology companies will remain a major market driver. But investors are ready for the so-called Magnificent Seven companies – Nvidia Corp. and Apple Inc. and Microsoft Corp. and Alphabet Inc. and Amazon.com Inc. and Meta Platforms Inc. And Tesla Inc. – To report slowing growth. : Earnings are expected to rise 22%, compared with average earnings growth of 34% in 2024, when the rest of the S&P 500 rose 4.5%, according to BI.

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Trade, tariffs and taxes

Investors are also looking for insight into how President-elect Donald Trump’s tax cuts, tariffs and deregulation policies will trickle down to corporate America. While some of his plans threaten to upend global trade and stoke inflationary pressures, the stock market has focused more on the positive side of the pro-growth agenda.

However, the type of tax cuts being considered in Washington may only reduce the tax burden on the S&P 500 by about half compared to the 2017 package, according to BI’s Casper. This adds another hurdle to achieving sharp earnings-per-share growth in the S&P 500 over the next 12 months, he said.

The recent rise in the value of the dollar is another open question: while this may offset the impact of higher tariffs by reducing import costs, it may also darken the outlook for multinational companies by reducing export demand and the value of profits abroad.

Profit reviews

Traders are monitoring a key indicator known as earnings revision momentum, a measure of upward to downward changes in expected earnings per share over the next 12 months for the S&P 500. It has been hovering in negative territory, BI data shows, suggesting Wall Street analysts are trimming Their estimates ahead of earnings season.

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While this is not unusual, it may be an early sign of changing feelings. For example, 12-month earnings per share (EPS) revision momentum in the technology sector has declined for 11 of the past 12 weeks, driven by price cuts from high-flying semiconductor companies.

Three of the 11 sectors in the S&P 500 are expected to see earnings growth accelerate by double digits in the final three months of 2024, including communications and technology services, along with previously unpopular groups such as health care. Energy companies are expected to post a roughly 30% profit contraction from a year earlier in the fourth quarter, according to BI data.

Observation margins

Traders will be watching operating margins closely after inflation eases from the post-pandemic high, easing some cost pressures. Analysts see fourth-quarter operating margins at around 16%, with the worst of the pain in the rearview mirror as the outlook improves in coming quarters, data compiled by BI show.

Profits wave in Europe

Expectations for European profits are much calmer, as the continent faces stalled economic growth at home and in China, an important trading partner for luxury goods and automobile companies. The possibility of US tariffs is a concern for export-heavy industries in 2025.

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Gains for the Stoxx 600 are expected to rise just 3% in 2024, compared with 8% for the S&P 500, and are likely to decline again this year, BI data show. The focus will be on automakers such as Volkswagen, which faces threats from protectionist policies, tepid demand in China and the loss of US tax breaks for some electric cars. Luxury companies including LVMH and Gucci-parent Kering SA will be leaders in consumer spending patterns.

“The big picture for European equities is that the growth environment remains very difficult,” said Liliane Chauvin, head of asset allocation at Coutts.

– With assistance from Sagarika Jaisinghani and Michael Msika.

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