[UNITED STATES] As the U.S. stock market enters the crucial fourth-quarter earnings season, investors are eagerly anticipating a potential revival of the faltering rally that has defined much of the past two years. With the S&P 500 experiencing its worst drop since mid-December on Friday, falling 1.5% due to an unexpected surge in hiring, market participants are looking to corporate earnings reports as a beacon of hope to reignite momentum.
The High Stakes of Q4 Earnings
The upcoming earnings season carries significant weight, as it represents a critical juncture for the market's trajectory in 2025. Analysts are projecting a robust 7.3% year-over-year increase in earnings for S&P 500 companies during the fourth quarter, marking the second-highest pre-season forecast in the past three years. This optimistic outlook sets a high bar for companies to meet or exceed, potentially putting equities on shaky ground if results fall short of expectations.
Michael Casper, senior equity strategist at Bloomberg Intelligence, emphasizes the challenge ahead: "We haven't seen a hurdle this high since 2018. It's going to be a lot harder for companies to continue to beat profit estimates this year than in 2024 because the bar was much lower then".
Banking on Financial Sector Performance
The earnings season will officially kick off on Wednesday, with financial behemoths JPMorgan Chase, Citigroup, and BlackRock leading the charge. The performance of these banking giants will set the tone for the broader market, providing crucial insights into the health of the financial sector and the overall economy.
S&P 500 companies' profits are predicted by analysts to increase by roughly 7.8% in the fourth quarter and 12% in 2024. This forecast emphasises how much pressure is on corporate America to produce solid outcomes and keep the market moving upward.
Broadening Growth Beyond Tech Giants
One of the key themes to watch this earnings season is whether profit growth will extend beyond the dominant tech sector. While the so-called "Magnificent Seven" companies – Nvidia, Apple, Microsoft, Alphabet, Amazon, Meta Platforms, and Tesla – have been the primary drivers of market gains, investors are now looking for signs of broader-based earnings growth.
Expectations are for companies outside of big tech to report a third consecutive quarter of earnings growth, with profits estimated to rise 4% and accelerate towards double-digit increases by the first quarter of 2025. This potential broadening of growth could provide a much-needed boost to market laggards and contribute to a more balanced rally.
Margin Pressure and Inflationary Concerns
As inflation has moderated from its post-pandemic peak, investors will be keenly focused on operating margins. Analysts project operating margins for the fourth quarter to be nearly 16%, with forecasts improving in the coming quarters. The ability of companies to maintain or expand margins in the face of ongoing cost pressures will be a critical factor in determining the sustainability of earnings growth.
Global Economic Headwinds
While U.S. companies are expected to show resilience, the outlook for European earnings is more subdued. The continent faces challenges from stunted economic growth at home and in China, a crucial trading partner for luxury goods and automotive industries. The specter of potential U.S. tariffs also looms large for Europe's export-heavy sectors in 2025, adding another layer of uncertainty to the global economic landscape.
The Federal Reserve Factor
The recent strong jobs report has solidified speculation that the Federal Reserve won't cut interest rates until the second half of the year. This shift in monetary policy expectations could have significant implications for corporate earnings and market valuations. Investors will be parsing earnings reports and forward guidance for clues on how companies plan to navigate a potentially higher interest rate environment for longer than previously anticipated.
Sector Spotlight: Technology and Healthcare
While the tech sector's earnings growth is expected to moderate, it remains a key driver of market performance. Taiwan Semiconductor Manufacturing Company's results will be closely watched as a barometer for the global semiconductor industry. In the healthcare sector, UnitedHealth Group's earnings will provide insights into the state of the U.S. healthcare system and insurance markets.
Risks to the Bullish Outlook
Despite the overall optimistic projections, several risks could derail the anticipated earnings-driven rally. Capital Economics identifies five key risks to their bullish forecast for the S&P 500 in 2025, with faltering demand for Artificial Intelligence technologies being a primary concern. The potential for geopolitical tensions, shifts in consumer spending patterns, and unexpected regulatory changes also pose threats to corporate profitability.
Market Reaction to Earnings Surprises
Historical data suggests that the market's response to earnings surprises may be muted compared to previous seasons. Companies reporting positive earnings surprises for Q2 2024 saw an average price increase of 0.8% in the days surrounding the earnings release, below the 5-year average of 1.0%. This trend indicates that investors may be more cautious in their reactions to earnings beats, potentially dampening the impact of positive surprises on stock prices.
Looking Ahead: Full-Year Projections
While the focus is on fourth-quarter results, analysts are already looking ahead to full-year 2025 performance. Citigroup expects the rally in global stocks to extend into 2025, projecting 10% earnings per share growth. This optimistic outlook is tempered by the knowledge that 70% of companies issuing Q1 2025 guidance provided negative outlooks, above historical averages.
As the earnings season unfolds, investors find themselves at a crossroads. The strong two-year rally that has characterized the market is facing its most significant test yet. The ability of companies to meet or exceed the lofty expectations set by analysts will be crucial in determining whether the stock market can regain its momentum or if a period of consolidation lies ahead.
John Lynch, chief investment officer for Comerica Wealth Management, captures the sentiment of many investors: "We've had a nice run here, but we need to see some fundamental improvement. Earnings season gives us that opportunity".
With the S&P 500 trading at a forward price-to-earnings ratio of 20.2, well above historical averages, the pressure is on for corporate America to deliver results that justify these elevated valuations. As earnings reports begin to roll in, market participants will be watching closely for signs of continued growth, margin resilience, and forward-looking guidance that can fuel the next leg of the stock market rally.
The coming weeks will be critical in shaping market sentiment and setting the tone for what promises to be an eventful year in global finance. Whether earnings season can indeed revive the faltering stock rally remains to be seen, but one thing is certain: investors are poised for a period of heightened volatility and potentially significant market moves as corporate America opens its books on the final quarter of 2024.
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