Editor’s Note: Due to travel there will be no Cornerstone blog post next Monday.
Earnings season is complete and thus appropriate to fully assess the fundamental foundation that was laid. I also want to touch on some high points regarding recent “consternation noise” to put some things to bed.
Let’s start with four key metrics that came out of this earnings season:
- For the S&P 500*, 81% of companies reported positive per-share earnings surprises and 81% reported positive revenue surprises (higher than 5 year averages):
2. Growth: The blended year-over-year earnings growth rate for the second quarter was 11.9%, which is the third consecutive quarter of double-digit growth.
3. Upward Revisions: The EPS growth rate ended up at 11.9%, but on June 30 (when earnings season started), the projection was only 4.8%. All but one sector reported higher earnings due to positive EPS surprises:
4. Guidance: Already 52 S&P 500 companies have issued positive forward EPS guidance for next quarter.
To drill down, I want to touch on the all-important “Magnificent 7” stocks. They’ve been the main drivers of S&P 500 growth and have now all reported earnings. How have they performed relative to expectations and performance a year prior?
Early expectations were for Mag 7 companies to grow their earnings by 13.9%. All of them reported positive EPS surprises. In aggregate, Mag 7 companies exceeded estimates by 12.7%% compared to +5.6%% for the other S&P 500 companies:
That level of strength led to four of the Mag 7 companies being among the top six contributors to earnings growth for all of the S&P 500 for last quarter:
Interestingly, Warner Brothers and Vertex were coming off easy comparisons to weaker earnings year-over-year, whereas NVIDIA, Amazon, Meta, and Microsoft beat difficult YoY comparisons.#
Why is this important? It’s because analysts expect Magnificent 7 earnings growth rates of 14.5%, 14.5%, 14.5% and 16.8% for the next four quarters, respectively. But if the trend holds, they’ll easily outperform, continuing to provide significant foundational support for the growth prospects of the overall S&P 500 economy:
If past quarters are any indication, it provides some comfort to the overall earnings picture over the next year.
“Concerns” in the Market
Understanding the strength at the macroeconomic and microeconomic levels for this past quarter, let's turn to the initial forward-looking expectations and estimates for the third quarter. This is especially important given the continued “concerns” in the market about inflation and tariffs.
Let’s see if those “concerns” have caused analysts to lower EPS estimates more than normal at this early stage. The short answer is no.
For example, during the months of July and August, analysts increased third-quarter EPS estimates. The bottom-up EPS estimate (an aggregation of median quarterly EPS estimates for all companies) increased this past earnings season by 0.5% from June 30-Aug. 28:
So there’s an early increase in estimates in the face of these “concerns.” Notice how in the previous four quarters there were earnings revision decreases without these “concerns.”
Typically, analysts will embark on a mission of CYA (cover you’re a*%) by reducing earnings estimates during the first two months of the quarter.
During the past five years, which is 20 quarters, the average decline during the first two months of the quarter has been 1.0%.
During the past 10 years (40 quarters), the average decline during the first two months has been 2.5%.
The current positive projection is the first since 2024’s second quarter. Combine that with the Mag 7 outperformance and it’s clear to us at Cornerstone that we just completed an earnings season providing a strong fundamental foundation and outlook for the equity markets.
Now let’s drill down to a sector level, which matters in terms of asset allocation. Five of the 11 sectors saw an increase in bottom-up EPS estimates:
The growth-oriented sectors leading the charge are encouragingly bullish. Technology is expected to grow EPS by 4.4%, communications services by 2.6%, and financials by 1.6%.
Energy is expected to grow, though that’s mostly because of past poor performance setting up an easy comparison. The other three are demonstrating pure sector strength and coming off difficult comparisons, meaning they merit consideration for further sector investment allocation strength on a go forward basis.
Challenge That Narrative with Evidence
Coming right out of Labor Day, stocks dipped because of the headline announcement that tariff revenue might have to be refunded. The market initially reacted negatively because returning tariff money would ultimately make American credit less attractive. This caused the 30- and 10-year Treasury yields to rise, hence the early-week market dip.
We’re not going to litigate this situation here. But we want address the “risk” of these rising yields being cause for concern.
If you’re of the belief that slight upticks in interest rates are stock market killers, we would challenge that narrative with evidence. Keep in mind, stock markets have dealt with elevated rates ever since the Fed began its inflation fight around four years ago. Stocks have continuously surprised pundits with their resiliency, especially over the past two years or so.
Let’s readdress and reinforce strength in stocks despite “higher interest rates.” In the face of the recent news, we saw the 30-year yield tick up to a three-month high, approaching 5%:
Our friends at MoneyFlows were kind enough to research going back to 1978 showing how, in the short to intermediate forward-looking time period, there’s plenty of resilience and market strength in the S&P 500:
We’d expect the same, even if the 30-year rate were to unexpectedly hold at this level.
But what about the 10-year yield?
Even though the news talked about 30-year, let’s address the 10-year yield because that's what we concentrate on more here anyways. The 10-year yield nearly hit 4.3%:
Notice how the spike wasn’t nearly as big as the 30-year situation, which alone is positive for equity markets.
But let’s analyze further with historical data. Even if there was a delayed risk of the 10-year yield spiking over 5%, if there is no recession, the S&P 500 historically has gained 11.3% in the following year, even in the face of unexpected rate risk:
So, there's no practical correlation in this current scenario between a short-term spike in higher rates and equity performance. We're better off focusing on fundamental matters like earnings, as dPreview Websiteiscussed above.
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*Past performance does not guarantee future results.
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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
# Microsoft, Amazon, NVIDIA, and Meta are owned in Cornerstone client accounts and by Daniel Milan personally; Warner Brothers and Vertex Pharmaceuticals are not owned by Cornerstone clients or Daniel Milan personally.
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