Something unusual is happening on Wall Street - and it likely bodes well for stocks

By Joseph Adinolfi

Something unusual is happening on Wall Street that is helping to boost the confidence of stock-market bulls as the first half of 2024 comes to a close.

Corporate-earnings estimates, which typically decline throughout the course of a year, are actually growing, according to FactSet data.

According to data shared with MarketWatch by FactSet's John Butters, S&P 500 SPX firms have seen their earnings-per-share estimates for the 2024 calendar year increase by 2.4% since late December, to $244.79. By comparison, bottom-up estimates have fallen 2.6%, on average, during the first six months over the previous 10 years.

    Date End   Date Start  Year   EPS End  EPS Start  Change % 
   6/30/2014  12/31/2013  CY14     121.03     122.63     -1.3% 
   6/30/2015  12/31/2014  CY15     121.31     128.82     -5.8% 
   6/30/2016  12/31/2015  CY16     119.61     127.70     -6.3% 
   6/30/2017  12/31/2016  CY17     131.94     133.22     -1.0% 
   6/30/2018  12/31/2017  CY18     161.12     147.57      9.2% 
   6/30/2019  12/31/2018  CY19     166.79     174.04     -4.2% 
   6/30/2020  12/31/2019  CY20     126.34     177.34    -28.8% 
   6/30/2021  12/31/2020  CY21     189.95     166.55     14.1% 
   6/30/2022  12/31/2021  CY22     228.08     222.02      2.7% 
   6/30/2023  12/31/2022  CY23     218.37     229.34     -4.8% 
   6/17/2024  12/31/2023  CY24     244.79     239.09      2.4% 
   Average         -2.6% 

Estimates have been climbing for 2025 as well - rising by 4% to $279.46, compared with an average decline of 1.7% for the second year out. According to the latest figures, Wall Street analysts expect the S&P 500 will report year-over-year earnings growth of 11.3% in 2024 and 14.4% in 2025.

   Date End   Date Start  Year    EPS End  EPS Start  Change % 
   6/30/2014  12/31/2013  CY15     134.90     136.09     -0.9% 
   6/30/2015  12/31/2014  CY16     135.66     143.58     -5.5% 
   6/30/2016  12/31/2015  CY17     135.78     143.88     -5.6% 
   6/30/2017  12/31/2016  CY18     147.31     148.64     -0.9% 
   6/30/2018  12/31/2017  CY19     177.03     162.61      8.9% 
   6/30/2019  12/31/2018  CY20     185.02     192.99     -4.1% 
   6/30/2020  12/31/2019  CY21     162.71     196.13    -17.0% 
   6/30/2021  12/31/2020  CY22     211.57     194.33      8.9% 
   6/30/2022  12/31/2021  CY23     248.79     243.39      2.2% 
   6/30/2023  12/31/2022  CY24     243.42     251.83     -3.3% 
   6/17/2024  12/31/2023  CY25     279.46     268.80      4.0% 
   Average         -1.7% 

This optimism is helping to embolden bullish investors at a time when the list of complaints expressed by market skeptics is already long and growing.

Some common ones include: Valuations for large-cap stocks are looking rich; the S&P 500 is growing dangerously dependent on just one stock, Nvidia Corp. (NVDA); political risks - particularly centered around the U.S. and its upcoming election - appear to be underappreciated by investors; and the timing of the Federal Reserve's promised interest-rate cut looks increasingly uncertain, even as official data suggest the U.S. economy has started to buckle under the weight of interest rates at multidecade highs.

Still, most Wall Street strategists remain undaunted, with a number of them recently raising their price targets for 2024. Some seized on companies' rising forecasts to justify their increasingly sunny outlooks.

"[W]e've been surprised by how rapidly expectations for earnings have grown," said a team at Capital Economics on Friday, in a report announcing their decision to raise their 2024 price target for the S&P 500 to 6,000.

Expectations vs. reality

To be sure, earnings expectations are merely that - expectations. Typically, Wall Street's forecasts for the largest companies are shown to be too conservative. This was the case in the first quarter, when S&P 500 firms substantially outperformed Wall Street estimates, largely due to contributions from Nvidia and other giant firms like Microsoft Corp.

The return to a torrid pace of earnings growth during the first quarter marked an important departure from 2023, when an "earnings recession" - that is, two or more quarters where earnings for the largest publicly traded U.S. companies contract when compared with the same periods a year earlier - caused earnings to grow just 1%.

Despite this recent turnaround, skeptics are concerned that the artificial-intelligence boom has introduced an element of uncertainty to Wall Street's earnings outlook. The upshot is that nobody knows exactly when the AI revolution might deliver on its promise to substantially boost worker productivity.

So far - aside from Nvidia and a handful of companies involved in the production of semiconductors and the data centers that house them - few companies have seen much of a boost to their profits due to AI.

The Capital Economics team acknowledged the risk that earnings expectations might be too optimistic. But the analysts ultimately concluded that there hasn't been a good reason to doubt them, given that earnings growth for the largest U.S. firms was so much stronger than expected in the first quarter.

For better or worse, Wall Street doesn't expect Nvidia and its peers to sustain the breakneck pace of earnings growth seen over the past year. Consensus forecasts for the S&P 500 anticipate that the 10 largest stocks' contribution to overall earnings growth will decline during the second half of 2024, while the contribution from the other 493 companies in the index is expected to climb. This trend is expected to continue through the first quarter of 2025.

The big question: Can margin growth keep up?

Some bearish investors see a potentially troubling inconsistency between Wall Street's earnings expectations and expectations for sales growth.

According to the most recent estimates from FactSet, sales are expected to grow by just 5% in 2024 and 5.8% in 2025 - suggesting that companies will likely need to expand net margins to meet Wall Street's profitability targets.

Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, recently highlighted one potential headwind that could make it more difficult for companies to squeeze out more profits from their earnings going forward.

According to emailed commentary from Shalett shared with MarketWatch on Monday, consumer prices are no longer rising more quickly than wholesale prices, sapping some of companies' pricing power.

With their ability to raise prices limited, any further margin expansion will likely need to come from cost cutting, lower labor costs or increased worker productivity, Shalett said.

Others who were once skeptical about the ability of companies to further expand margins say they're coming around.

S&P 500 companies reported an aggregate net profit margin of 11.8% for the first quarter, not far from the record 12.2% margin achieved in 2021, according to FactSet.

This has helped convince James Abate, fund manager of the Centre American Select Equity Fund DHAMX, that the largest American companies might be able to continue expanding their margins in the quarters ahead. He previously saw this as a potential stumbling block for the rally.

"I'm becoming more optimistic about it," Abate said in a phone interview with MarketWatch on Monday.

U.S. stocks traded mixed on Monday, with the S&P 500 losing 0.3%, to 5,447.87, and the Nasdaq Composite COMP shedding over 192 points, or 1.1%, at 17,496.82. Both indexes were hurt by a 6.7% decline in Nvidia shares that saw the megacap tech stock officially enter correction territory.

The Dow Jones Industrial Average DJIA, meanwhile, gained over 260 points, or 0.7%, to close at 39,411.21.

-Joseph Adinolfi

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06-25-24 0600ET

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