The markets weren’t asking for much in the third quarter, so the 5.9 percent earnings growth we received delivered all that was asked for: It was above the 4.2 percent analysts were expecting when we entered earnings season. The “Magnificent Seven,” which includes Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla, produced nearly all the growth of the S&P 500 with 21 percent growth for the quarter—above the 19 percent that was expected going into earnings season. This result is in spite of the fact that Apple reported earnings of $0.97 per share versus the expectation of $1.60 per share due to a $10.2 billion charge related to the impact of an adverse ruling in Europe regarding tax payments. The rest of the index had a really low bar, with an expected earnings decline of 1 percent that they managed to beat with growth of 1 percent.
Markets rewarded earnings beats, delivering an average price increase of 1.6 percent from the two days before reporting earnings to the two days after, which is above the 5-year average price increase of 1 percent. On the other hand, high valuations contributed to an average price decrease of 3.1 percent when companies missed earnings, which was above the 5-year average decline of 2.3 percent. As we move into 2025, we expect high valuations will continue to place greater importance on not only beating earnings but also delivering solid guidance to continue to see price increases.
When we look at the presents Santa delivered, the communications sector delivered the biggest gift, with a positive earnings surprise of 11.8 percent. This included a range of companies that beat estimates, including Take-Two Interactive, Fox Corporation, Alphabet, Meta, and Electronic Arts. Consumer discretionary also delivered 10.8 percent earnings beats, with a broad range of companies beating earnings, including Garmin, Nike, Hasbro, Deckers, and Amazon.com. Health care, industrial, and financial sectors rounded out the best performers relative to expectations. The materials and tech sectors received “coal” during the quarter, with the aforementioned Apple weighing heavily on the tech sector.
Source: FactSet Consensus Analyst Estimates, as of 12/6/2024
We entered the quarter waiting to see if the rest of the index outside of the Magnificent Seven could close the earnings growth gap. Still, it was the largest companies that continued to provide the engine for growth in the U.S. During the quarter, analysts lowered estimates for the future in line with historical averages but projected that those companies would continue providing the lion’s share of U.S. growth. Fourth-quarter estimates have the Magnificent Seven seeing 24 percent growth versus the rest of the index at 8 percent. They expect a similar story in 2025, with 21 percent growth for the Magnificent Seven and 13 percent for the rest of the index.
While it may be healthy to see a broadening of growth throughout the economy, given the heavy weight of the Magnificent Seven in the index, the markets will likely rely on growth in those companies in the near future.
Sources: J.P. Morgan Asset Management, FactSet, Standard & Poor’s Guide to the Markets – U.S., as of 12/6/2024
In the midst of a solid earnings season, we also had an election, which helped drive valuations above 22x forward earnings (levels we saw in 1998 and 2020). While both periods saw significant growth in the subsequent years, it is difficult to continue to satisfy high expectations, as we saw in both cases. If earnings continue to surprise to the upside, it could justify the current valuations, but we expect valuations to come down as growth expectations begin to level out.
Given the high growth expectations, we could see valuations come down while prices go up, which could be healthy for the market. Investors should also consider other parts of the market outside of large-cap growth companies. These companies are trading closer to historical averages, and a broadening of the market could benefit them.
As investors, it’s important to recognize the positive fundamentals of the market while also being mindful that we don’t get carried away with expectations for the future. For now, we’re wishing everyone a great holiday season and to be grateful for all the gifts we’ve received.