Once again, the "Magnificent 7"—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla—are having an outsize impact on the results. (UBS)

Macro benign
During the fourth quarter, economic data was solid. The labor market is cooling, but initial claims for unemployment insurance remain low, the unemployment rate of 3.7% is near historical lows, jobs continue to be added in the most cyclical segments of the labor market (manufacturing and construction), there are still 1.4 open jobs for every unemployed worker, and real wages are rising. Consumer finances are also in good shape—with nearly USD 1 trillion of excess savings on household balance sheets—and spending is holding up as evidenced by indications that the holiday shopping season was in line with expectations. In addition, inflation continues to improve, with the six-month annualized change in core PCE inflation already back to the Federal Reserve’s target. As a result, interest rates have fallen, which should support rate-sensitive parts of the economy such as housing. Putting it all together, the macro data suggests a fine 4Q23 earnings season.


Results should be fine
Given this generally favorable backdrop, we are expecting 4–5% EPS growth for the S&P 500 in 4Q23. Our estimate reflects earnings beats of 3–5%, which is in line with the 21 companies that have already reported results. These early reporters generally do a good job setting the tone for the full earnings season. This “normal” level of earnings beats is also consistent with the economic data that we highlighted above.


While 4–5% earnings growth would be a slight decline from the 5.8% pace in 3Q (Fig. 2), bear in mind that there are a few nonrecurring items that are weighing on growth in the quarter. First, Merck is taking a large noncash charge related to a recent acquisition. Second, uptake of COVID vaccines and therapeutics continues to be lackluster. And finally, the labor strikes at Ford and GM are also having an impact. Together, these items are depressing EPS growth by about 2.5 percentage points. So our headline estimate of 4–5% understates the true “recurring” EPS growth for the benchmark.


Once again, the "Magnificent 7"—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla—are having an outsize impact on the results. This group of companies should report earnings growth of about 50%. Earnings for the rest of the S&P 500 should be down modestly year-over-year.


Initial guidance appears mixed
As always, we are closely watching management team guidance for 1Q24 and the full year 2024. Based on the momentum in the economy, we see no reason why guidance should be disappointing. However, guidance from the early reporters has been somewhat mixed, with estimates for the first quarter falling by 4% for the median company. This is a slightly larger drop than the typical 1–2% cut to expectations—which ultimately gets beaten anyway once the quarter is reported. On a more positive note, full-year 2024 estimates for the early reporters have been fairly stable. Still, if the early reporters are indicative of the full set of results, markets may have some difficulty digesting the mixed tone to guidance.


Bumping up 2023, maintaining 2024 and 2025
Based on our expectations for 4Q, we are slightly bumping up our full-year 2023 S&P 500 EPS estimate from USD 220 to USD 223. Our new number reflects 1% growth versus 2022. We leave our full-year estimates of USD 240 (8% growth) and USD 255 (6% growth) for 2024 and 2025 unchanged. For comparison, the bottom-up estimate for full-year 2024 stands at USD 244.


We are not concerned that bottom-up EPS estimates may have some downside risk. Since 1990, bottom-up consensus EPS estimates for the calendar year have been nearly 6% too high on average at the start of the year—yet the S&P 500 has notched an average gain of 9.4% per year. So a slight downward revision in consensus estimates shouldn’t be a headwind for stocks. The chart below shows that there is very little correlation between S&P 500 returns and changes in the bottom-up EPS estimate over the course of the year.


At first blush, it may seem strange that EPS growth should improve in 2024 despite our expectations for a slowdown in GDP growth. But we remind investors that there are important differences between the economy and profits for publicly traded companies. First and foremost, the US economy is much more heavily weighted toward services than are S&P 500 profits.


The goods segment of the economy has been in the doldrums for the last 18-plus months after the surge in goods consumption during the pandemic as well as higher interest rates. This headwind should continue to wane in 2024. Second, lower oil prices are reducing S&P 500 EPS growth by about 3% in 2023, despite the fact that lower oil prices are a “tax cut” for consumers. As mentioned, weak uptake of COVID vaccines and other one-time items in healthcare are also depressing EPS growth in 2023. This headwind should recede in 2024. Finally, EPS growth of only 1% in 2023 looks low relative to GDP growth that should be around 2.4% in 2023, which underscores our point that there are important differences between the economy and profits.


While S&P 500 EPS growth got a boost from the Magnificent 7 in 2023, this tailwind will likely diminish over the course of 2024. Due to increasingly difficult comparisons for the Magnificent 7, a pickup in semiconductor sales, the previously mentioned dynamics in healthcare, and the end of the headwind from the energy sector, the rest of the S&P 500 could be outgrowing these mega-cap growth stocks by the end of 2024. At a minimum, the differential in growth rates between the Magnificent 7 and the rest should narrow in 2024.


Bull run has more to go, but be cognizant of entry points

After the strong market rally in the last two months of 2023, we wouldn’t be surprised if markets experience modest downside volatility through results season. While the market gains were largely driven by lower interest rates and expectations that the Fed could start cutting rates in the coming months, the equity rally may have some investors expecting a pronounced improvement in the outlook for corporate profits. We think these investors may be disappointed. Instead, we expect management teams to indicate no substantial change in the outlook. Still, with the economy likely on pace for a soft landing, the Fed in a position to start cutting interest rates (we expect 100bps of cuts in 2024 starting in May), and our view for durable growth in corporate profits in the coming quarters, any selloff should be fairly mild and could represent an opportunity to increase exposure to stocks. If there is no recession, the S&P 500 tends to perform well after the Fed starts to cut rates. We maintain our June and December S&P 500 price targets of 4,900 and 5,000.


Main contributors: David Lefkowitz, Nadia Lovell, and Matthew Tormey


Read the original report S&P 500 EPS—good enough? 11 January 2023.