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THOUGHTS OF THE WEEK: July 12th

The Pendulum Swings Back to the Micro (from Macro)! This week marks the official start to 2Q24 earnings season, with the big banks among the first to report. While much of the last six weeks has been dominated by the softening macro backdrop, the S&P 500 looked past the weakening data—notching 37 record closes already this year. The reason: improving earnings. And with earnings a fundamental driver of the equity market, the next six weeks will provide a glimpse into how companies and consumers are navigating the growth slowdown. The results will be key to whether stocks can hold onto and potentially build on their recent gains or suffer a nearterm pullback. Below we provide an early look at some of the key trends that will drive the market in the weeks ahead and whatto expect during the upcoming earnings season:


  • Headline Figures Poised to Accelerate | With valuations at the highest level since 2021, earnings will need to be the catalyst to drive the market higher as current valuations have already priced in much of the good news. Fortunately, given the resilience of the economy up until this point, earnings are on track to rise at a healthy pace. In fact, consensus expectations for S&P 500 earnings are for them to climb 9.5% on a year-over-year basis in 2Q24—the fourth consecutive increase and the fastest pace since 4Q21. More important, if earnings beat by even a touch, 2Q24 earnings growth could easily end up with a double-digit gain! Despite the slowdown in the economy, top-line sales growth should record its 15th consecutive positive quarter, with sales rising (+4.5%) at their fastest pace since 4Q22. In addition, margins—a major tailwind for S&P 500 earnings in recent quarters—should remain above their 10-year average (10.8%) for the 14th consecutive quarter and expand to the highest level (12.4%) since 4Q21.


  • Tech Remains a Standout/Rest of Index Improving | In 2Q, seven out of the 11 sectors are expected to post positive EPS growth. Much like recent quarters, EPS growth will be led by tech-related sectors, with communication services (+22% YoY) and info tech (+16% YoY) expected to deliver the best earnings growth. While mega-cap earnings (MAGMAN*) should slow from the recent ascent, earnings growth should remain robust at a 30% YoY pace! The key difference this quarter: the rest of the Index outside MAGMAN will start to contribute to S&P 500 earnings growth. In fact, S&P 500 ex-MAGMAN earnings growth is expected to be ~6.5% YoY—thanks to a positive reversal in healthcare and energy earnings. This will be the highest earnings growth for S&P 500 ex-MAGMAN since 3Q22. More important, their earnings are expected to accelerate through year-end, closing the gap with MAGMAN’s earnings growth—a key reason why we expect a broadening of performance beyond mega-cap tech going forward.


  • Higher Bar For Earnings Could Lead To Volatility | In the 12 weeks leading up to the 2Q24 earnings season, S&P 500 earnings were revised down only 0.1%—marking the second smallest downward revision in 11 quarters and well below the previous 10- year average decline of 3.5%. This set up will make it more challenging for companies to solidly beat their earnings forecast. The higher earnings bar could drive up volatility, particularly with valuations at current levels. For companies who do not beat or guide higher, they are more likely to see their stock price punished given the market’s lofty expectations. However, with the S&P 500 only experiencing one 5% pullback this year (typically 3-4 5% pullbacks occur in any given year) and the 2nd smallest intrayear drawdown (5%) over the last 25 years, any earnings misses could spark a near-term pullback.


  • Next Year’s Earnings Are Too Optimistic | The resilience of full-year estimates has been a driver of positive performance throughout the year. In fact, strength in the tech-related sectors has driven full-year earnings estimates for 2024 ($242) and 2025 ($278), to be revised up slightly and remain unchanged YTD respectively. This is relative to the typical downward revision of 3% and 4% at this juncture on average. While we expect earnings to move higher going forward, 2025’s EPS estimate (15% growth over 2024) is likely too optimistic as we expect economic growth to moderate going forward.


  • Consumer in Focus | Consumer spending has been a key driver of economic growth in the current expansion. However, recent data suggests that the consumers’ resilience is fading—particularly among the lower-income earners. In fact, management calls from some of the early reporters (e.g., Nike, Walgreens, and General Mills) corroborate this theme as companies are reporting consumers are starting to pull back. With the consumer making up ~70% of GDP, it will be crucial to monitor how the consumer evolves heading into the third quarter as this will likely dictate the direction of economic growth. With consumer spending expected to moderate over the next 12 months, this will likely be a headwind for the consumer discretionary and staples sectors.



Chart of the Week

Net Margins Poised to Expand Further Net margins, which have been a key tailwind for earnings over recent quarters, are set to expand to the highest level since 4Q21 in 2Q24.


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