With 99 percent of the S&P 500 reporting, 79 percent beat earnings expectations. This is just above the five-year average of 77 percent. But they beat estimates by only 3.6 percent, well below the 8.6 percent average the market has gotten used to over the past five years. Market valuations had risen to 21x forward earnings estimates during reporting season, which caused investors to punish earnings misses more severely this quarter. Companies saw a 4.4 percent average decline from the two days before to two days after missed earnings estimates—worse than the historical 2.3 percent average decline. Conversely, companies saw only a 0.9 percent gain if they beat estimates. It’s tough to remain on top.
As we entered earnings season, the Magnificent Seven (i.e., Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) were expected to drive earnings with 28 percent growth, while expected growth for the rest of the index was only 4 percent. The top names met those high expectations, delivering 35 percent growth for the quarter. The rest of the index, on the other hand, had only 6 percent growth.
Nvidia may be a prime example of rising expectations, as it beat earnings estimates by 5.2 percent during the quarter but still saw its stock price fall 6.4 percent after reporting earnings. This story is likely to persist in the third quarter, with the Magnificent Seven expected to report growth of 18 percent, while the rest of the index is expected to show growth of only 1 percent. Analysts are expecting earnings growth to broaden out beyond the third quarter. How that plays out with the current dispersion in valuations could affect relative performance between the top names and the rest of the index.
From a sector perspective, the top names drove the earnings picture in their respective sectors, including Apple, Microsoft, and Nvidia in tech; Amazon in consumer discretionary; and Meta and Alphabet in communication services. But there were still solid earnings across the board. Nine of 11 sectors reported year-over-year growth in the second quarter. Utilities, financials, and health care were three of the top five sectors. All saw double-digit growth—and these sectors do not contain any of the Magnificent Seven. Relative to expectations at the beginning of the quarter, utilities and financials handily beat earnings expectations. There was broad-based growth within these sectors, with no single name providing the reason for the earnings beat.
Source: FactSet Consensus Analyst Estimates (as of 9/6/2024)
On the negative side, communications services suffered, primarily due to Warner Bros. Discovery taking a $9.1 billion write-down of goodwill primarily related to its TV assets and the uncertainty of fees from cable and satellite distributors. Several energy names guided down and/or missed earnings in Q2, including Chevron and Exxon Mobil due to lower refining margins. Falling oil prices after quarter-end could continue to put pressure on those firms but could also lead to better margins for companies where oil is a cost.
While the market was expecting more from companies in the second quarter, analysts lowered expectations for the third quarter providing an easier bar for companies to beat with growth expectations of only 4.9 percent. Still, with valuations hovering above 20x forward earnings, companies will likely need to give analysts a reason to maintain their 15 percent earnings growth expectations in the fourth quarter and for the full year in 2025. Revenues that were just above 5 percent in the second quarter are expected to remain there, continuing to put pressure on firms to maintain high profit margins through cost reductions to meet those earnings targets.
Despite some disappointing economic data recently, expectations remain high. And just like any fan hoping for a Super Bowl or bust, it might be tough not to be disappointed. Despite that, counting out the biggest U.S. companies or a quarterback like Patrick Mahomes is something I’m not ready to do.