Given the U.S. stock market’s strong bounce—the S&P 500 has risen 6.5 percent in the past eight trading sessions—one might assume that the Q3 earnings season is going swimmingly. But that’s not quite the case.
Credit for the stock market rally goes to the bond market and the Fed. As the 10-year Treasury yield declined from the nearly 5.0 percent nosebleed level in October to 4.5 percent recently on dovish Fed comments, the S&P 500 regained its footing and bounced.
While major markets around the world will likely remain fixated on Treasury yield movements for the time being, investors should not ignore the mother’s milk of equity returns: corporate earnings trends.
S&P 500 Q3 earnings have been good enough to end the three-quarter-long “earnings recession,” as profits are now growing on a year-over-year basis. But management teams’ comments and guidance about future quarters have been cautious, reinforcing question marks about profits and the economy in 2024.
Beating estimates, but by how much?
With 90 percent of companies having reported so far, the S&P 500’s Q3 earnings and revenue growth rates are pacing at 4.1 percent and 2.0 percent year-over-year, respectively, according to FactSet. These figures are modestly higher than the consensus forecasts at the start of earnings season.
- 80 percent of companies have beaten the consensus earnings forecast, above the long-term average.
- But the magnitude of earnings beats (the degree to which earnings growth has exceeded the consensus forecast) has lagged the long-term average.
- 62 percent of companies have beaten the consensus revenue forecast, roughly in line with the long-term average.
- But the magnitude of revenue beats has also lagged.
Q3 earnings growth is on pace to break the negative streak of the past three quarters
S&P 500 earnings growth year over year (dark blue are actual data; light blue are consensus estimates)
Column chart showing year-over-year S&P 500 quarterly actual earnings growth and consensus forecasts since Q1 2022. In 2022, the change in earnings were 9.6% in Q1, 6.3% in Q2, 2.4% in Q3, -4.7% in Q4. In 2023, it was -1.5% in Q1, -2.8% in Q2, and the consensus forecast is for 4.1% in Q3 and 7.0% in Q4. For 2024, the consensus forecast is for 8.2% in Q1, 11.6% in Q2, 9.6% in Q3, and 16.3% in Q4.
Source - FactSet, LSEG I/B/E/S, RBC Wealth Management; data through 11/9/23
Cautious forward guidance
As usual, management teams haven’t been very eager to provide specific guidance for future quarters. Among those that have, more executives have lowered Q4 earnings estimates than have raised them.
Overall, management teams have struck a cautious tone about the future.
After reviewing numerous earnings conference call transcripts, RBC Capital Markets, LLC Head of U.S. Equity Strategy Lori Calvasina pointed out the following:
- “The conversations on outlooks, demand, and the general macro [picture] have generally tilted negative. Some companies have emphasized resiliency, stabilization, and normalization, but we are reading a lot more about uncertainty, challenging macro conditions, softening, and caution.”
- “Risks and negative impacts from rising rates stand out. This echoes our quantitative work which suggests the recent rise in 10-year Treasury yields has taken the interest rate backdrop to a trouble spot.”
- “Inflation and costs are still generally discussed as being problems.”
This caution is bleeding into industry analysts’ forecasts. While estimates typically come down in the first month of a new quarter, the consensus earnings forecast for Q4 has taken a bigger hit than usual. It declined 3.9 percent in October, much more than the average declines of 1.9 percent and 1.7 percent in the first month of each quarter during the past five years and 20 years, respectively, according to FactSet.
All of this leaves us skeptical about the 2024 consensus earnings forecast of $246 per share. This figure implies year-over-year growth 11.4 percent above the 2023 consensus forecast.
For this to pan out, we think the economy would need a clear path toward a soft landing, along with prospects for some above-trend GDP growth quarters.
Earnings forecasts seem too lofty
S&P 500 quarterly earnings per share (dark blue are actual data; light blue are consensus estimates)
Column chart showing actual quarterly earnings in dollars for the S&P 500 from Q1 2021 through Q2 2023, and the consensus quarterly earnings estimates in dollars for Q3 2023 through Q4 2024. The pattern shows earnings rising from $48.55 per share in Q1 2021 to $55.66 per share in Q2 2022. Then earnings pulled back until Q2 2023, reaching $54.29 per share. In Q3 2023, earnings are projected to rebound to $57.93 per share, and then pull back in Q4 2023 before they resume and upward trend in subsequent quarters in 2024. The final estimate is for $64.96 per share in Q4 2024.
Source - FactSet, LSEG I/B/E/S, RBC Wealth Management; data as of 11/8/23
Recession: the elephant in the room
RBC Global Asset Management Inc. Chief Economist Eric Lascelles remains skeptical about the U.S. economy’s potential. He thinks high interest rates will ultimately take their toll. Over the next 12 months, Lascelles now sees a 70 percent likelihood of the U.S. entering a recession, up from his previous estimate of 65 percent.
We continue to think earnings growth and the stock market’s performance in 2024 will be highly dependent on whether a recession materializes.
As things stand now, the 2024 consensus estimates for the S&P 500 and its sectors look too lofty to us.
Wall Street analysts typically don’t firm up their year-ahead forecasts until the early months of the new year as more management teams provide guidance. As this happens, 2024 earnings estimates could be trimmed—especially if there are signs of economic vulnerabilities.
S&P 500 and sector consensus earnings growth estimates for 2024
Bar chart showing S&P 500 and sector consensus earnings growth estimates for 2024: S&P 500, 11.4%; Communication Services, 16.8%; Consumer Discretionary, 12.1%; Consumer Staples, 7.0%; Energy, 3.9%; Financials, 6.2%; Health Care, 19.1%; Industrials, 12.0%; Information Technology, 14.6%; Materials, 4.7%; Real Estate, 4.1%; and Utilities, 8.7%.
Source - RBC Wealth Management, LSEG I/B/E/S; data as of 11/3/23
We think the range of potential economic and earnings outcomes for next year remains rather wide. The rosy scenario of a soft landing and above-trend GDP growth could play out, but it is also possible that the economy could succumb to pressures from high interest rates.
We continue to recommend Market Weight exposure to U.S. equities, a stance intended to balance the risk of a recession against the possibility that one may be averted.