Research: Overview of Expected Earnings for Q3 and Trends to Watch

Some macro context

As of mid-2024, the U.S. economy has regained solid footing. The labor market has adjusted smoothly back to pre-pandemic levels, showing strength without the overheating that could spur significant inflation.

Core personal consumption expenditures (PCE) inflation has eased to 2.6% from a peak of 5.6%, and it seems poised to approach the Federal Reserve’s target by next year.

Given this favorable trend, the market anticipates that the Fed will begin a cautious rate-cutting cycle later this year, with September being the most probable time for the initial reduction.

Review of U.S. corporate earnings

Corporate earnings were strong in 1Q24 and for the one-fourth of US companies that have already reported 2Q results, despite ongoing concerns about persistent inflation, robust economic data, and reduced expectations for Fed rate cuts, which somewhat tempered the Q1 momentum.

Even if this growth has been driven by a select group of high-performing mega-cap stocks (the Magnificent Seven*), profits for the broader large-cap S&P 500 and small-cap Russell 2000 indices are also stabilizing to positive territory (as exhibited in the chart below).

In greater detail, the Mag 7 companies boasted an average year-over-year EPS growth of over 50% from 2Q23 to 1Q24. In contrast, the growth for the S&P 493 (S&P 500 minus the Magnificent Seven) was negative for the same period.

Nevertheless, 1Q24 was a pivotal moment for the S&P 493, marking the start of an earnings recovery. Analysts forecast that as the year advances, EPS growth for the S&P 493 will improve, while growth for the Magnificent Seven is expected to decelerate.

Smaller-caps offer the largest upsides

Turning to smaller-cap stocks, they have been more affected by higher interest rates compared to their larger counterparts but also showed initial signs of stabilization in Q1.

The Russell 2000 Index’s earnings growth was nearly flat year-over-year in Q1, a notable improvement from the negative growth rates experienced in FY23. Analysts predict a significant rebound in small-cap earnings, with year-over-year growth potentially exceeding 50% by the end of Q4 2024.

A stock picker’s paradise

As this earnings-growth gap is expected to close later this year, this presents a compelling opportunity for stock selection, as earnings feed valuations.

While the “Magnificent 7” mega-caps were priced at roughly 34x earnings as of late June, the other 493 stocks in the S&P 500 traded at a much less demanding 17x, and just below that for the Russel 2000 (including only companies with positive earnings).

We leave you with a recent quote from Tony DeSpirito, Global Chief Investment Officier, Fundamental Equities at BlackRock “A market in which earnings growth broadens beyond the prevailing leaders ― creating dispersion in the process ― is a stock picker’s paradise”.

*The list includes Apple, Microsoft, Amazon, Alphabet (Google), Tesla, Nvidia and Meta Platforms

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