What Q4 Earnings Say About Stocks

Q4 earnings season is wrapping up, and another better-than-expected quarter underscores Corporate America’s strength. But this is hardly a revelation for forward-looking markets. Stocks have been pricing in the ongoing earnings upturn since this bull market began in October 2022. For investors, backward-looking quarterly reports only confirm what stocks spied long ago, once again demonstrating their uncanny ability to move first—and highlighting the folly of waiting for all-clear signals.

With about 80% of S&P 500 companies’ Q4 results in, overall earnings are up 3.2% y/y versus the 1.5% expected at yearend, continuing the return to positivity that began in Q3 2023.^[i] Four sectors saw double-digit earnings growth: Communication Services (45.1% y/y), Consumer Discretionary (32.8%), Utilities (30.5%) and Tech (20.8%). Meanwhile, four other sectors saw double-digit earnings declines: Energy (-25.1% y/y), Materials (-20.3%), Health Care (-16.7%) and Financials (-15.0%).

Sector dispersion notwithstanding, analysts are penciling in market-wide earnings acceleration every quarter this year. Current consensus expects 3.5% y/y earnings growth in Q1, 4.6% in Q2, 5.0% in Q3 and 5.7% in Q4.^[ii] And those estimates ordinarily prove low. Over the past five years, 77% of companies on average have reported actual earnings above estimates.

Corporate profit margins were particularly notable last quarter. (Exhibit 1) The S&P 500’s Q4 2022 – Q2 2023 earnings decline wasn’t about revenues—they rose. It was largely about higher expenses impacting the bottom line. But firms adapted, cutting costs and boosting efficiency. Now that is apparently bearing fruit in select sectors—Tech, Communication Services and Consumer Discretionary—with wider margins contributing to their double-digit earnings growth last quarter.

Exhibit 1: Markets Appreciate Margin Improvement

Source: FactSet Earnings Insight, as of 2/16/2024.

Not coincidentally, those sectors are leading the bull market. (Utilities’ margins also improved considerably, but mainly because of declining commodity prices—note Energy’s earnings decline.) It isn’t just AI-hype, in our view. Tech and Tech-like sectors are becoming more profitable. With the profit margins of the world’s biggest companies expanding, they are now leaner and meaner. Their dominance in the S&P 500 isn’t an accident. Each of these sectors’ sales growth (Communication Services’ 7.6% y/y, Tech’s 7.1% and Consumer Discretionary’s 5.9%) tops the S&P 500’s 4.0%.^[iii] More of that falling through to the bottom line bodes well for their continuing profitability—and earnings growth.

From a higher level, though, Q4’s positive results are nothing new for stocks. Yes, yes, how an individual release compares to expectations may result in daily gyration. But the lasting impact is minimal, as these profit reports are backward-looking—months in the rearview. Stocks, as always, are focused on earnings 3 – 30 months out and how those fare against present perceptions.

Many investors may be getting fear of heights with the S&P 500 near record levels. But in our view, they should be reassured. Earnings’ strength is confirming what stocks’ run has already priced. We think stocks are the ultimate leading indicator for earnings, and on that measure, they don’t look likely to disappoint anytime soon.