CIO continues to expect S&P 500 EPS growth of 3–4% in the third quarter, representing a beat of a similar magnitude relative to consensus expectations. (UBS)

Guidance from companies on the profit outlook for the final quarter is also down nearly 2%, weaker than prior quarters.

But, the first full week of earnings was dominated as usual by banks. This week’s results should provide a clearer view, with 40% of companies by value reporting, including Alphabet, Amazon, Meta, and Microsoft. We expect the results to confirm our view that profits will return to growth after three quarters of year-over-year declines.

The macro backdrop remains supportive. The resilient US economy continues to surprise positively. As the third quarter progressed, consumer balance sheets were shown to be in better shape than previously thought, labor market strength continued, and inflation fell further. Consumer spending, which accounts for 70% of US economic activity, accelerated in the third quarter, and we believe the changes in expectations for real GDP growth from flat to 3% should provide additional support for earnings.

Earnings are being driven by mega-cap growth stocks. We believe much of the earnings improvement will be driven by the seven largest tech and growth companies, the “Magnificent 7.” This group got off to a disappointing start last week, after electric-vehicle maker Tesla missed both earnings and revenue expectations—which contributed to a 15.6% decline in the company’s stock last week. However, overall we still expect this group of seven leading companies to announce earnings per share growth in the region of 30%. We'll be looking for updates on cloud optimization, rollout of artificial intelligence applications, and capital expenditure trends.

In terms of the remaining constituents of the S&P 500 index, while the consensus forecasts are for modest declines, beyond the worst-performing outliers trends are improving for the average company. Earnings for the median company are expected to grow at a mid-single-digit rate. In addition, S&P 500 earnings revisions have registered a notable improvement this year. On a net basis, analysts are modestly upgrading forward estimates.

Margin expansion looks set to continue. While we believe lower inflation is likely to have weighed on corporate revenue growth during the third quarter, we estimate costs cooled at a faster pace. So, we forecast profit margin expansion to continue from last year's fourth-quarter lows. Indeed, profits are more heavily weighted toward goods rather than services, and the shift away from goods consumption in 2022 has been a big drag on profits over the last few quarters. But we believe the “goods recession” looks to be fairly far along and will likely weigh less on profit growth going forward.

So, we continue to expect S&P 500 EPS growth of 3–4% in the third quarter, representing a beat of a similar magnitude relative to consensus expectations. Overall, we expect earnings growth for the S&P 500 to be flat this year, followed by 9% growth next year. While we are neutral on equities overall, and we are least preferred on the US market, we do see upside over the medium term. We maintain our June 2024 and December 2024 S&P 500 price targets of 4,500 and 4,700, respectively, from 4,224 at the end of last week.

Read the original report : US earnings set to improve, despite slow start, 23 October 2023.