When kids are young they don’t ask for much, maybe a toy car or a puzzle will keep them happy, but as they get older the requests always seem to get bigger. Those toys and puzzles, become more complicated and bigger Legos or video games, or designer clothes and was invariably something we never had as kids.
Markets weren’t asking for much in the third quarter so the 5.9 percent earnings growth we got in the quarter delivered all that was asked for, above the 4.2 percent analysts were expecting when we entered earnings season. The magnificent seven which include Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla delivered nearly all of the growth of the S&P 500 with 21 percent growth for the quarter, above the 19 percent that was expected going into earnings season. This is despite the fact that Apple reported earnings of $0.97 per share versus the expectation of $1.60 per share due to a $10.2 billion charge related to the impact of an adverse ruling in Europe regarding tax payments. The rest of the index had a really low bar with an expected earnings decline of 1 percent which they managed to beat with growth of 1 percent.
Markets rewarded earnings beats delivering an average price increase of 1.6 percent from the two days before reporting earnings to the two days after which is above the 5 year average price increase of 1 percent. On the other hand high valuations contributed to an average price decrease of 3.1 percent when companies missed earnings which was above the 5-year average decrease of 2.3 percent. As we continue to move into 2025, high valuations will continue to place greater importance on not only beating earnings but delivering solid guidance to continue to see price increases.
Looking inside Santa’s Bag
When we look at the presents Santa delivered, the communications sector delivered the biggest gift with a positive earnings surprise of 11.8 percent. This included a range of companies which beat estimates including, Take-Two Interactive, Fox Corporation, Alphabet, Meta, and Electronic Arts. Consumer discretionary also delivered 10.8 percent earnings beats with a broad range of companies beating earnings including Garmin, Nike, Hasbro, Deckers, and Amazon.com. Health care, industrials, and financials sectors rounded out the best performers relative to expectations. Materials and tech were those that received coal during the quarter with the aforementioned Apple weighing heavily on the tech sector.

While we entered the quarter looking to see if the rest of the index outside the Magnificent Seven could close the earnings growth gap, those companies continued to provide the engine for growth in the U.S. During the quarter analysts lowered estimates for the future in line with historical averages, but continue to project the largest companies to provide the lion’s share of growth in the U.S. Fourth quarter estimates have the Magnificent Seven seeing growth of 24 percent versus the rest of the index at 8 percent. They expect a similar story in 2025 with growth of 21 percent for the Magnificent Seven and 13 percent for the rest of the index. While it may be healthy to see a broadening of growth throughout the economy, given the heavy weight of those companies in the index, we will continue to be reliant on growth in those companies for the near future.

How High Can Expectations Go?
In the midst of a solid earnings season, we also had an election, which helped drive valuations above 22x forward earnings, levels we saw in 1998 and in 2020. While both of those periods saw significant growth in the subsequent years, it is certainly difficult to continue to satisfy high expectations as we saw in both cases. If earnings continue to surprise to the upside it will certainly justify the current valuations, but we will need to see valuations come down as growth expectations begin to level out. Given the high growth expectations, we could see valuations come down while prices continue to go up, which could be healthy for the market. Investors could also consider other parts of the market outside large cap growth companies which are trading closer to historical averages, where a broadening of the market could benefit those companies.
As investors we need to recognize the positive fundamentals of the market, while also being mindful that we don’t get carried away with expectations for the future. Wishing everyone a great holiday season and being grateful for the gifts we’ve all been given.
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