What Q3 earnings reporting season is telling us.
There is a new Nike commercial on TV featuring NBA superstar LeBron James. In the advertisement, he sits with his eyes closed, sweat glistening on his brow, talking softly to himself as if in prayer, with his voiceover saying: “Expectations aren’t a burden. They’re a privilege. Because it could be worse. No one could expect anything at all.”
As I sat down to write this week’s missive, LeBron’s words came to my mind as related to the stock market. We’re a quarter of the way through earnings season and 76% of S&P 500 index companies have beaten analysts’ earnings estimates so far, according to FactSet. However, year-over-year earnings per share (EPS) growth is coming in at just 3.4% for S&P 500 companies this quarter. It is forecast to be 14% next quarter and 15% in 2025. With valuations sky-high, that’s a lot of privilege built into those expectations.
Attention shifts next week to mega-cap and big-tech earnings with five of the Magnificent Seven companies on tap. Tech shares have been volatile because of concerns of slowing long-term growth prospects. But info tech is still leading all sectors with year-over-year quarterly EPS growth at 15.6%, though this is down from a 20% growth rate in the second quarter. AI remains front and center.
With that, a surprisingly strong earnings report from Tesla sparked a rally in the electric-vehicle maker’s shares, leading tech stocks higher. After the company reported a 17% year-over-year increase in net income for the third quarter and CEO Elon Musk signaled high growth in 2025, shares of Tesla closed up 22% yesterday, their best day since 2013.
Market participants also received encouraging earnings news from American Airlines, UPS, Southwest, Lam Research, Whirlpool and T-Mobile. Shares of many of those, along with Tesla, powered consumer discretionary and info tech sector gains. That said, Honeywell, IBM, Dow, Union Pacific, and Northrop Grumman reported mixed results.
Amid the throes of this earnings season, it was notable this week that Goldman Sachs offered a prediction that the S&P 500 index will return an average of just 3% per year in the next decade, a far cry from the 13% average annual return of the last 10 years. That return would rank in the bottom decile of comparable periods in the last century, and mean it is unlikely stocks will outpace inflation. 10-year forecasts from other Wall Street firms for S&P 500 performance range from a low of 4.4% to a high of 7.4%, with the average being 6%.
So why the pessimism? One of the primary causes is the market’s extreme concentration in the Magnificent Seven (Apple, Nvidia, Microsoft, Alphabet, Amazon, Meta and Tesla). Concentration in the index is near its highest level in 100 years and it makes the performance of the S&P 500 overly reliant on the earnings growth of the index’s largest constituents. History shows us it is extremely difficult to sustain earnings growth at a high clip. In fact, just 11% of S&P 500 companies since 1980 have maintained double-digit sales growth for 10+ years, according to Goldman’s analysis. A microscopic proportion of stocks (0.1%) have sustained 50%-plus margins for a decade.
It’s a good thing that growth is expected to pick up for the other 493 index constituents, and that’s why we are encouraging you to embrace diversification within the U.S. stock market and elsewhere globally.
The other big news this week is just how much the yield curve continues to move, with the 10-year U.S. Treasury Note now at 4.25%. Over time, higher yields increase borrowing costs for companies and consumers, while dollar strength often clips overseas revenue. This combination can hinder future earnings growth, a concern with major U.S. indexes at historically high valuations and as analysts prognosticate 15% earnings gains next year.
On a final note, we received multiple reports of firm U.S. economic data, including jobless claims, new home sales, consumer confidence, and purchasing managers’ index readings. It was a break from some of the more uneven readings we have received on inflation and construction and affirms the “no recession” outlook for 2025. As we dig into the final quarter of the year and count down to the election, it is time for our discussions to center on expectations, hopes and goals, and it is our privilege to help you consider those plans today and always.
Thank you for your interest in our weekly investment commentary. If you would like to speak personally with a member of your advisory team, please call 833.RWA.PLAN (833.792.7526).