The US Stock Market Is Facing a Real Test in a Time of High Income

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(Bloomberg) — The U.S. stock market’s strongest two-year rally since the dot-com bubble is entering its next big test as companies begin releasing quarterly earnings, providing a major test of whether valuations have outpaced ground truth.

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On Friday, the S&P 500 Index fell 1.5% – its worst decline since mid-December – as an unexpected increase in expectations that the Federal Reserve will not cut interest rates again until the second half of the year.

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But the bigger problem is the lofty goal set by investor ratings: Reports are expected to show that a strong economy boosted earnings at companies in the S&P 500 by 7.3% during the fourth quarter from a year ago, according to aggregated data. by Bloomberg Intelligence. That’s the second-highest pre-season forecast in the last three years, and it threatens to put shares on a downward spiral if the results – or the outlook for the coming months – fall.

With the S&P 500 priced at about 23% earnings growth per share over the next 12 months, the embedded estimates for stock prices are unusually high, BI data show. Consensus forecasts from the top — a method of predicting future stock performance by combining individual analyst estimates for each S&P 500 company — call for EPS growth of 13% by 2025, meaning those numbers would need to nearly double to confirm where the S&P is. 500 trade.

“We haven’t seen a hurdle this high since 2018,” said Michael Casper, chief equity strategist at BI. “It will be more difficult for companies to continue to exceed profit margins this year than in 2024 because the bar was so low then.”

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Fourth-quarter earnings season will officially begin Wednesday, led by financial providers JPMorgan Chase & Co. and BlackRock Inc. Several key companies will report results next week, including Netflix Inc., Procter & Gamble Co. and 3M Co.

Here are five key themes to watch for as the results come in:

Increase Growth

Another issue being watched is whether the pace of earnings growth will overtake the big tech companies, which could provide a boost to some of the market’s laggards.

With the economy performing well, companies outside of high technology are expected to report a third straight quarter of earnings growth, with profits averaging 4% and accelerating to double-digit growth in the first three months of 2025, according to data compiled by. BI.

Technology companies will still be a key market driver. But investors have prepared for companies called the Magnificent Seven – Nvidia Corp., Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc., Meta Platforms Inc. and Tesla Inc. – reporting a slowdown in growth : Profits are expected to increase by 22%, compared to average earnings growth of 34% in 2024, when the entire S&P 500 is up by 4.5%, according to BI.

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Trade, Duties and Taxes

Investors are also looking at how President-elect Donald Trump’s policies of tax cuts, tax cuts and deregulation will affect Corporate America. While some of his plans threaten to increase global trade and fan inflationary pressures, the stock market is more focused on the height of the growth agenda.

But the kind of tax cuts being considered in Washington would only reduce the tax burden on the S&P 500 by about half as much as the 2017 package, according to BI’s Casper. He said that adds another hurdle to meeting the strong EPS growth posted on the S&P 500 over the next 12 months.

The recent rise in the dollar is another open question: While that may offset the impact of the tariff hike by reducing import costs, it may also dampen the outlook for multinationals by reducing export demand and the amount of overseas revenue.

Benefit Review

Traders are watching a key indicator known as earnings revision momentum, a gauge 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 show, indicating that Wall Street analysts are cutting estimates. their when they go to the income period.

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Although that is normal, it may be the first sign of a change in attitude. The technology sector’s forward 12-month EPS revision momentum, for example, has declined in 11 of the past 12 weeks, driven by markdowns at 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 telecommunications and technology services, as well as unpopular groups such as health care. Energy is forecast to post a profit of nearly 30% from a year earlier in the fourth quarter, BI data show.

Monitoring Margins

Traders will keep a close eye on operating margins after inflation eases from the post-pandemic outbreak, easing some cost pressures. Analysts see fourth-quarter operating margins of around 16%, with more pain in the rearview mirror as forecasts improve in the coming quarters, data compiled by BI show.

European Earnings Tide

Europe’s earnings prospects have dimmed sharply as the continent grapples with economic stagnation at home and in China, a key trading partner for its luxury goods and auto companies. The prospect of US tariffs is a concern for its heavy export industries by 2025.

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Profits for the Stoxx 600 are expected to increase by just 3% in 2024, compared to 8% for the S&P 500, and will do so again this year, BI data show. The focus will be on automakers like Volkswagen AG facing threats from protectionist policies, hot demand in China and the loss of US tax credits for some connected vehicles. Luxury firms including LVMH and Gucci-parent Kering SA will be rivals for consumer spending patterns.

“The big picture for European currencies is that the growth environment remains very challenging,” said Lilian Chovin, head of asset allocation at Coutts.

—With help from Sagarika Jaisinghani and Michael Msika.

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