We attribute the strong showing to a number of factors: a much more resilient than expected US economy; falling inflation; the winding down of the Fed’s rate hikes; investor enthusiasm about artificial intelligence; and an improvement in corporate profits. With respect to profits, forward bottom-up S&P 500 EPS expectations have staged a notable rebound this year and are now back to all-time highs.
Perhaps somewhat surprisingly, the profit improvement is fairly broad. Since peaking last July, profit expectations for the median company in the S&P 500 are up 5.6%. Expectations are at or above all-time highs in every sector except energy, healthcare (due to the falloff of COVID-related benefits), and materials. Consistent with our view for a "soft-ish" economic landing, we think it’s highly likely that the earnings recession (year-over-year decline in reported profits) that began in 4Q last year and continued into 2Q this year is over.
The improving profit picture is one of the key reasons that we think the market can hold on to its year-to-date gains. To be sure, most of the gains have been driven by valuation expansion, but investors should not lose sight of the fact that profit dynamics have also been supportive. Our 2023 EPS estimate is in line with the bottom-up consensus—USD 220 (0% y/y). But our 2024 estimate of USD 240 (+9% y/y) is a bit lower than expectations for USD 248.
Still, we think stocks could be somewhat range-bound in the coming months as the US economy slows a bit (student loan repayments restart, excess household cash is dwindling, labor market is cooling). In addition, the low-hanging fruit on inflation improvements has been picked, and further disinflation will likely be more incremental. Our December 2023 and June 2024 S&P 500 price targets are 4,500 and 4,700, respectively.
Main contributor: David Lefkowitz, Nadia Lovell, Matthew Tormey
Original report: S&P 500 profits—back to all-time highs , 5 September, 2023.