As we close out 2024, the overall trend remains up, with near-record profits and margins driving the stock market. The direction of profits is the most important determinant of whether stocks go up or down. A stock is an investment vehicle to participate in a future stream of cash flow, and the most important factor is the direction of earnings.
Earnings growth is key, and the S&P 500 is expected to see an overall earnings increase of around 10% this year, marking a fourth year of earnings growth. Next year is also expected to see earnings growth. Corporate America is still retaining a large share of profits compared to revenues, with the estimated net profit margin for the S&P 500 for 2024 at 12.0%, near a record and above the 10-year average of 10.8%.
Tech stocks, such as Nvidia and Broadcom, have been winning because they are where the profit growth is. The artificial intelligence story has become an investing paradigm, similar to the internet in the late 1990s. The direction of earnings is crucial, as seen in the S&P 500 technology sector, which has reported much higher earnings than the rest of the S&P 500.
The pace of earnings growth is important, and the Magnificent Seven, a group of megacap tech companies, have been driving the growth. These companies have strong earnings outlooks, with estimated growth of 33% in 2024 and 18% in 2025. However, estimates for the other 493 stocks in the S&P 500 are expected to rise, particularly in the back half of the year.
Despite hopes for a “rotation” from megacap tech to other sectors, the author is skeptical, citing two reasons. First, even slow growth for these companies would still be impressive compared to the rest of the market. Second, the estimated earnings gains for other sectors are not set to be as strong, with a 14% increase anticipated in 2025.
The new year, 2025, will be unsettling, with wild cards including the potential for policy errors from the Federal Reserve and the incoming Trump administration. Inflation is still persistent, and there is a risk of policy mistakes that could affect the economy and earnings.
