Equity View: SPX Earnings Outlook Relies on Tech

Summary 

• The S&P 500 earnings have been little changed since early 2022 – but are projected to jump 11% in 2024. 
• This top-level performance blurs considerable variation across sectors. Since early 2022, industrials and energy sectors have been stars while communications and financials have been notable laggards. 

• Projected 2024 earnings growth relies heavily on the communications, consumer discretionary, and technology sectors.  
• These sectors are dominated by the tech giants, such as Google, Amazon, Apple, and Microsoft.  

Market Implications 

• Analyst earnings forecasts tend to assume current earnings and economic trends will persist.  
• With the Federal Reserve (Fed) apparently nearing a higher-for-longer policy stance, current earnings projections across the market and especially the tech sector will surely be tested – with likely consequences for equity valuations. 

Introduction 

We noted recently that the S&P 500 (SPX) earnings on both a trailing and forward basis (through yearend 2023) have been essentially flatlined since early 2022 – but that full-year 2024 earnings are expected to rise by 11% (Chart 1).  

This is a big deal because equities track earnings growth closely, and investors pay much more attention to earnings projections than trailing earnings (Chart 2).¹ 

Here we dig into what is and will drive earnings at the sector level. The SPX is a large-cap index, but it is also highly diverse (Table 1). As we shall see, earnings vary widely across sectors.  

What About 2022-23? 

Comparing earnings for the years ending in Q1 2022 and Q2 2023, we see that across many sectors earnings are modestly higher or lower. But there are notable exceptions (Chart 3):  

• Financials (XLF) were down 22% given the pressure of rising rates and the regional bank crisis after the Silicon Valley Bank failure.  

• Communications (XLC) were down about 20% following an unsustainable surge during the Covid lockdowns. 
• Industrials (XLI) jumped 43%. Earnings collapsed 55% in 2020 when lockdowns hit, then gradually recovered after the 2020 US presidential election. 
• The huge winner by far was the energy sector (XLE), where earnings soared 140% when energy prices spiked after the Russian invasion of Ukraine. 

Earnings across other sectors rose or fell by less than 10% between Q2 2022 and Q2 2023. 

It is more useful to look at changes in earnings weighted by market cap. Even though the energy sector is only 5% of the SPX by market cap, it contributed six percentage points to SPX earnings (Chart 4). The tech sector (XLK) and industrials also made substantial contributions, offset by financials and communications. 

Bottom line – the earnings for the overall SPX may have been stable over the past 15 months, but there has been a fair amount of variability beneath the surface. 

What Is Coming in 2024 

As noted, full-year 2023 SPX earnings are expected to be little changed from Q2 2023 levels and up 11% in 2024. Focusing on 2024, earnings for most sectors are expected to rise, especially the communications sector (XLC), consumer discretionary (XLY), and technology (XLK) on both an absolute and market cap weighted basis (Charts 5 and 6). Utilities are projected to rise 24% – but are only 2.5% of the SPX by market cap, so it has only minimal impact.  

A key point about these three sectors is that they are highly concentrated:  

• XLC – Alphabet (GOOG) and Meta Platforms (META) account for 31% and 15% of total market cap, respectively; the remaining 54% is spread across 21 other mostly more traditional media companies. 
• XLY – Amazon (AMZN) and Tesla (TSLA) account for 32% and 19% of total market cap, respectively; the other half is spread across some 50 companies. 

• XLK – Apple (AAPL), Microsoft (MSFT), and Nvidia (NVDA) account for 27%, 23%, and 10% of XLK, or 60%, respectively, of the sector. 

An earnings miss by any of these companies will meaningfully impact ultimate sector earnings performance. 

The only sectors that forecast a decline in earnings in 2024 are energy (XLE) and real estate (XLRE). Energy sector earnings forecasts were revised downward during Q1 when oil prices were in the $75-80 range. Given oil prices are now trading above $90/bbl, we would be unsurprised seeing earnings forecasts revised upward after Q3 earnings season. 

XLRE earnings are expected to fall nearly 50% due to higher rates and high office/retail vacancy rates. Offsetting this, XLRE is only about 2% of total SPX market cap. 

What Are Analysts Assuming? 

Analysts’ earnings projections usually assume current earnings and economic trends will persist. As we discussed in a recent note, analysts seem to be the last to recognize the economy is entering recession or shifting gears. 

Across earnings projections for 2024, there is an implicit expectation the recovery will remain robust. Industrial and utility earnings are slated to rise 17% and 24%, respectively, and energy and material earnings will be down or flat – consistent with a strong economy and little pressure on raw material inputs. And the tech sector is expected to regain whatever mojo it lost over the past year. In essence, the underlying assumption is the economy and markets will fully normalise and put the dislocations of the Covid era in the rearview mirror. 

That said, inflation pressures remain. The Fed is moving toward a higher-for-longer policy stance. If these latter trends continue, then eventually the economic outlook will likely turn less robust even if the economy largely normalises. And current robust earnings outlooks could be revised downward and put more downward pressure on equities or trap them in the current trading range. 

We are not disputing these earnings projections or saying they are wrong – but we think they assume many things will go right in the coming year, and that the uncertainty band around them is as large as it ever gets. 

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)