Wall Street’s upbeat earnings expectations set high bar for US companies

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US companies will have to deliver the biggest rise in profits in more than two years to avoid disappointing optimistic Wall Street analysts, setting a challenge for further stock market gains after a string of record highs.

S&P 500 stocks are this month expected to report year-on-year earnings growth of almost 9 per cent in the three months to June, the biggest quarterly increase since early 2022, according to analysts’ forecasts compiled by FactSet.

The index has climbed about 16 per cent in 2024, in a rally overwhelmingly driven by a handful of massive technology companies.

That has pushed stock valuations to their highest level in nearly three years, leaving room for disappointment if earnings fail to live up to their billing.

“We need earnings to catch up to where valuations [are],” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “I’m not suggesting that this will be an ‘uh-oh’ quarter where you don’t meet those expectations, but clearly the bar has been set fairly high.”

Investment banks, including JPMorgan Chase and Citigroup, kick off the season in earnest on Friday July 12 with financials dominating the early days. Microsoft, Google parent Alphabet and Tesla are scheduled to report on July 23.

Analysts typically cut their forecasts for corporate earnings as results season approaches but this quarter it has not happened to the same extent. Numbers have been trimmed by just 0.5 per cent, compared with an average of 3.4 per cent over the past five years, according to FactSet.

At the same time the tech rally has driven 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.

Line chart of S&P 500 forward price/earnings ratio showing Market rally raises the bar for earnings season

Those gains have relied heavily on five giant companies — Nvidia, Apple, Microsoft, Amazon and Meta — whose price/earnings multiples have expanded far more rapidly to an average of 34 times forecasts, up from 28 times. Nvidia’s multiple has risen to 41 times from 24 times in January as forecasts for artificial intelligence-related chip demand have risen.

However, Big Tech’s profit growth is expected to slow — to an average of 30 per cent year on year in the three months to June, according to Deutsche Bank’s predictions, down from 38 per cent in the previous quarter.

Analysts instead expect an earnings pick-up from the rest of corporate America to support any further market gains. But some believe the importance of the tech giants means even better-than-expected earnings from a household name in another sector may not be enough to offset the effect on the market of daily moves from Big Tech.

“Market sentiment is such that it’s not clear to me that good earnings from, say, a Pfizer or a Johnson & Johnson or Walmart can outweigh a good or a bad day [of share price performance] for Nvidia and Microsoft,” said Steven Sosnick, chief market strategist for Interactive Brokers.

“We may not be priced to perfection, but we’re priced for really, really good,” he added.

Binky Chadha, chief US equity and global strategist at Deutsche Bank, said he expected stronger earnings from energy and materials companies would offset the slower tech earnings growth but said the potential for a summer market rally was limited.

“At current levels and with valuations pretty robust, earnings growth is priced in. We expect earnings should be fine — but I don’t think necessarily that they would be a positive catalyst,” said Chadha.

Research from Goldman Sachs found that, historically, growth stocks with higher valuations have underperformed the market by 32 percentage points when missing forecasts — twice as much as stocks trading on lower multiples.

“Looking forward, we expect valuations will remain roughly unchanged and earnings growth instead will lift the S&P 500 . . . to a new high of 5,600 at year-end,” the bank told clients in a recent note.

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