Earnings Expectations Are High for the Right Reasons

Human nature is such that there are always some folks who put a negative spin on obviously good news. So as we head into the time of year when companies report their results for the second quarter, and with members of the benchmark S&P 500 Index projected to post their best earnings growth in two years, some are saying this is somehow a bad thing because “expectations are too high.” The implication is that there’s no way the economy is that strong, and investors are sure to be disappointed.

Consider the possibility that expectations are high for the right reasons. Based on bottom-up earnings projections compiled by Bloomberg Intelligence, S&P 500 earnings are forecast to grow 9.1% from a year earlier on revenue growth of 4.4%. It’s hard to describe those numbers as being a stretch in an environment of solid (if slowing) economic growth. The stock market isn’t the economy, of course, but nominal gross domestic product probably grew about 5.5% in the April though June period from a year earlier, so the revenue projections easily pass the macroeconomic smell test. Add to that the confluence of individual juggernauts that have propelled the broad market for several quarters with no sign of slowing, including Eli Lilly & Co., the maker of weight loss drugs, and Nvidia Corp., which still has the market for advanced chips cornered amid a boom in generative artificial intelligence.

But the single biggest reason for optimism may actually be the unloved stragglers.

What’s been striking the last couple of years is how a few large firms — the so-called Magnificent Seven — have carried both S&P 500 earnings growth and stock performance. Bears bemoaned narrow earnings breadth as a sign of a market that looked good on the surface but was troubled under the hood. What we’re starting to see now, though, is a broadening of earnings growth to such areas as ground transportation and energy, which could help broaden the stock market’s performance as well. The Magnificent Seven are estimated to report earnings gains of around 29% from a year earlier (still fast, but a bit slower for them), while other stocks in the index are forecast to start growing profits again. Sounds like a balanced and reasonable earnings mix to me.