From COVID stress, to a blowout recovery, to an earnings recession, to prodigious growth from the biggest names in Tech, earnings have been through a lot these past few years. But as growth and inflation normalize, so too should earnings. Indeed, 3Q results suggest S&P 500 earnings growth is reverting towards trend. With 343 companies (74.8% of market capitalization) reporting, our current estimate for pro forma earnings per share (EPS) is $62.10. If realized, this would represent y/y growth of 5.4% and q/q growth of 2.6%.

At the start of the quarter, analysts were predicting 3Q24 EPS growth of 7.3% y/y and 10.8% for 2024. However, given expectations for trend-like GDP growth, these seemed too rosy compared to the 10-year average of 8.1%. Since then, the 3Q estimate has been revised down by more than average, while the 2024 estimate now sits at 9%. Current estimates for 4Q, 2025 and 2026 of 12.4%, 14.6% and 12.7% are likely to meet a similar fate. The economy can amble along for a while, but not at the breakneck pace that would drive earnings growth of this magnitude. 

Nevertheless, companies are holding up well. So far, 75% have beaten on earnings, slightly below the 5-year average of 77%, and actuals are 4.7% above estimates. Sales are weaker with 62% of companies beating compared to the 5-year average of 69%. Of the 5.4% expected growth in EPS, revenues, margins and buybacks should contribute 5.4, 0.9 and -0.9 percentage points respectively. In 2022, inflation, wage growth and supply chain issues plagued profitability. In 3Q24, five sectors are still reporting margins below five-year averages. Normalizing costs, particularly in the health care and materials sectors, will be a source of earnings growth moving forward. Additionally, as rate and policy paths crystalize, companies are more likely to reinvest excess cash into their businesses rather than return it to shareholders. Revenue growth will therefore be an increasingly important driver of future earnings. 

Mag 7 are still crushing expectations, but capex is a concern

Of course, the most important driver these past two years has been the Magnificent 7. That isn’t likely to change this quarter. Analysts estimate that Mag 7 earnings will grow by 27.2% y/y compared to 0.5% for the remainder of the index. On a full year basis, the Mag 7 are expected to grow earnings by 36.2% versus 3.1% for the rest of the index. However, the focus this quarter isn’t the eye-catching earnings; it’s the eye-popping spending on AI. These 7 names are growing capital expenditures by an estimated 42% this year to arm themselves for the battle of technological supremacy. They are not slowing down anytime soon either; J.P. Morgan estimates Mag 7 capex will grow another 14% in 2025. Including R&D, the Mag 7’s total investment in AI is expected to reach $500 billion per year.¹

Although investors are increasingly concerned about return potential, CEOs believe underinvesting is far riskier than overinvesting. Companies have highlighted billions in incremental revenue, an estimated 30% boost to software engineering productivity, and profitable products in the pipeline.² Plus, these companies are not spending money they don’t have; they remain of the highest quality with free cash flow yields of 25%. 2024 capex estimates may have risen 19% since 4Q22, but earnings and free cash flow estimates have been revised up too.

Earnings growth is decelerating for the Mag 7 and accelerating for the rest

The Mag 7’s share of S&P 500 EPS growth is decreasing, reducing risk at the headline level. Though the broadening is on pause this quarter, the second derivate shows it’s still very much in play. As Mag 7 earnings growth decelerates, it is accelerating for the remainer of the index. In 2023, earnings for the S&P 500 ex-Mag 7 contracted by 4%. However, analysts are expecting them to contribute 29% of the growth in 2024 and 73% in 2025. 

This quarter, 8 out of the 11 sectors are actually contributing positively, but the cyclicals are slumping. Energy, industrials, and materials earnings have been in the doldrums with U.S. manufacturing activity for the past two years. Crude oil and natural gas prices averaged $75.5 and $2.2 compared to $83.1 and $4.2 over the past three years, hurting energy sector profitability. Weakness in materials is broad-based but acute in metals & mining given China’s importance in commodity demand. But the winds are changing. Manufacturing activity has been subdued as businesses paused durable goods investment until interest rate and regulatory outlooks clarify. The Fed cutting cycle and election results should remove some of that uncertainty. Moreover, U.S. fiscal spending related to energy and supply chain security plus renewed stimulus efforts in China should be a significant tailwind. A recovery in these cyclical sectors could drive the next phase of the broadening. 

This quarter, financials and health care are doing the heavy lifting. 79% of financials companies are beating on earnings with an 9% surprise. In fact, EPS growth estimates for the financials sector have been revised up from -0.9% at the end of the quarter to 6.9%. The beats have been driven by increased capital markets activity and better-than-expected credit performance as consumer balance sheets hold up. In insurance, moderating inflation and a decline in used car prices is benefiting auto margins. Moving forward, lower rates should accelerate growth in loan balances and investment banking fees.

In health care, 85% of companies are beating estimates and earnings have surprised by 9.1%. The pharmaceuticals subsector is driving growth as core drug portfolios continue to see sales momentum. Despite better-than-expected revenues, health care margins are still well below five-year averages of 9.7% at 7.7%. Improvement here should be a source of future earnings growth as inflation and labor shortages continue to abate.

The consumer sectors should inch along with household spending. As savings deplete and wage growth moderates, companies focused on non-discretionary products or value will likely outperform. Additionally, as falling mortgage rates boost home sales, the durable goods subsectors in consumer discretionary should see earnings growth pickup. Home furnishing, household appliances and homebuilders have all outperformed since rates peaked in April.³

Investment Implications

Although nominal growth is downshifting, moderate growth combined with low recession risk has historically been a supportive environment for equity returns. Even though the economy is slowing, investment opportunities are growing. Rate cuts should support a cyclical recovery, allowing less-loved sectors to join the tech party. This, in turn, should ease concentration and valuation risk at the index level. As we move deeper in the cycle, it is critical to ensure growth’s outperformance hasn’t left portfolios offsides. Proper protection will enable investors to capitalize on pockets of exceptionalism. Markets are not the economy, and with secular tailwinds and easing monetary policy, equities should be able to generate compelling returns for some time to come. 

¹ J.P. Morgan Markets. US Equity Strategy. “Fed Easing, Late-Cycle Reflation or Higher-for-Longer, US Exceptionalism, Elections.” October 8, 2024.

² J.P. Morgan Markets. Internet. “Back to School, Back to Work: Top Internet Questions & Top Picks to Year-End.” September 3, 2024.

³ Ned Davis Research. Rob Anderson and Thanh Nguyen. “Monthly sector update: Stimulus revived risk-on appetite.” October 2024. 

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