U.S. equities: Sturdier leadership extends the bull market

The U.S. has enjoyed a strong bull market for the past two years, with U.S. equities rallying around 60%. Economic resiliency, the start of a Fed easing cycle and the emergence of AI have been key contributors to this performance. Strong gains were mostly concentrated in the “Magnificent 7” in 2023 and the first half of 2024, but broader leadership is now emerging and should continue. Looking ahead, we expect extraordinary earnings growth will settle at still-elevated levels for mega-cap tech while reaccelerating in other areas of the market. This broadening, coupled with resilient economic fundamentals, policy tailwinds and secular trends, should support a more inclusive rally in the year ahead.

Earnings outlook remains supported

In 2024, earnings growth was primarily driven by profit margin expansion from the mega-cap tech names. As the inflation, wage growth and supply chain issues that plagued profitability in 2022 continue to abate, margin recovery should broaden with health care and consumer discretionary seeing notable improvement. However, the contribution to earnings from margins should normalize, and disinflation could also add some pressure by constraining pricing power. Buybacks should also remain tame as companies increasingly use excess capital to invest in their businesses rather than return it to shareholders. As such, revenue growth will be an increasingly important driver of future returns.

Altogether, markets are currently expecting S&P 500 earnings growth to accelerate from 0% in 2023 to 9% this year, followed by an impressive 15% in 2025 and 13% in 2026. We expect earnings growth will be robust and more broad-based, but if GDP growth normalizes towards trend, as we expect, then consensus estimates could be overly optimistic unless a broad-based corporate tax cut is delivered. However, any benefit from a corporate tax cut could be at least partially offset by weakness of multinational performance and a stronger dollar from proposed tariffs. If mid single-digit to low double-digit earnings growth were achieved, it would hinge upon continued economic resiliency, revenue growth and the other 493 companies pulling their weight.¹

Earnings breadth should drive market breadth

Underneath the surface, the composition of earnings is projected to shift as well. Earnings growth for the Mag 7 is expected to decelerate to a (still solid) 20% annual pace, while accelerating for the rest of the market (Exhibit 1). AI will continue to be a focal point, but the conversation is becoming more balanced with return-on-investment concerns weighed against impressive profits and cash flow generation. This is already reverberating in a more inclusive rally. The Mag 7 accounted for 63% of S&P 500 returns in 2023, and that share has stepped down to 47% so far this year.

Beneath the surface, certain sectors are just emerging from cyclical headwinds. Industrials, energy and materials earnings have been in the doldrums with weak U.S. manufacturing activity for the past two years. But as the cost of capital declines with interest rates, consumers and companies should resume capital intensive expenditures. Durable goods subsectors, particularly those tied to housing, should also see a boost. Financials should benefit from increased loan and insurance demand, a more favorable yield curve, normalizing M&A and IPO activity and prospects for deregulation, while falling rates also increase the relative value of bond proxy sectors like utilities and real estate. Lastly, consumer sectors can likely inch along with improving household purchasing power, but heightened price sensitivity will keep non-discretionary or value- oriented companies most supported.

The prospect of deregulation and corporate tax cuts may finally give investors conviction to add to previously unloved areas of the market, like value and mid/small cap stocks, which are also benefiting from earnings recovery and attractive valuations. However, volatility may be ahead should more growth-negative policies emerge, such as tariffs. Secular spending on AI, the energy transition and diversifying supply chains are also providing sizable tailwind for the market. The “hyperscalers” are accelerating capex to upwards of $200B this year and 2025 is set to be another year of significant investment.² This spending will benefit areas of the market like data center real estate, engineering and construction, nuclear and renewable power, energy transmission, gas-powered electricity, cooling technologies and the electrical components that connect it all (Exhibit 2).

¹ The other 493 companies are expected to contribute 29% of earnings growth in 2024, compared to 73% next year.

² Hyperscalers are the large cloud computing companies that own and operate data centers with horizontally linked servers that, along with cooling and data storage capabilities, enable them to house and operate AI workloads. Alphabet, Amazon (AWS), Meta, Microsoft and Oracle comprise the five major hyperscalers expected to spend $194B and $225B on capex in 2024 and 2025, based on Bloomberg consensus estimates.

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