Corporate earnings are crucial to 2024 stock market returns
Keith Lee
Stocks went on a months-long rally to unprecedented highs in early 2024. Contributors included hope for Federal Reserve (Fed) rate cuts, rising expectations for an economic soft landing, and investor optimism around artificial intelligence (AI)[1] and obesity drugs[2].
However, the fact that corporate earnings significantly improved late last year also played a pivotal role in the rally.
Earnings are key because stock returns are a function of earnings growth, dividend yield and the price investors are willing to pay for these earnings. Companies recently issued earnings guidance that pushed up full-year 2024 estimates. We view this as positive, reflecting a stable economy with firms able to navigate the current environment despite significantly higher interest rates.
Today’s returns depend on tomorrow’s expected earnings
The market is forward-looking, trading more on expectations of future growth than what’s already in the books. For this reason, we expect the market to focus more on 2025 earnings estimates by mid-year, which we think look a bit high. Future earnings depend on the broader economy and Fed rate policy. The more restrictive the Fed stays, the more difficult the environment for future earnings growth.
From a style standpoint, growth companies’ earnings outperformance relative to value companies means the valuation spread between the two has converged meaningfully. Of course, this relationship had become very stretched, so growth stocks went from being very expensive relative to value to merely expensive. However, if these aggressive 2025 earnings estimates turn out to be correct, then faster earnings growth and reasonable valuations should support growth outperformance in the future.
On the face of it, current conditions are generally favorable for growth stocks. Fed Chair Jerome Powell told Congress the Fed will cut rates this year. Risk-on sentiment, broader earnings growth and avoiding a recession all support stock gains and a broader rally beyond a handful of the very largest stocks.
However, one perhaps underappreciated concern for large-company earnings is that these firms generate significant revenues overseas. The reality is that Japan, Europe, and China are struggling economically.
Productivity is central to profit growth
In addition, we continue to see lasting challenges to productivity growth in the movement toward nationalism, deglobalization and demographic trends of social inequality and aging global populations. Why the sharp turn to talk about productivity? Because worker productivity is critical to corporate profit growth. We hope that advancements and uptake in AI[3] and other technologies may help offset these productivity declines over time.
Moreover, uncertainty remains high on several fronts, which we think explains today’s extreme market concentration. In addition to the economy, interest rates and inflation, wars and elections introduce other sources of potential volatility. Progress on any or all of these fronts could lead to broader market participation.
To summarise, near-term conditions for growth stocks are favorable, contingent on companies achieving aggressive future earnings targets. But it’s also important to acknowledge the high uncertainty around present economic conditions.
Trends support productivity and innovation
Longer term, we take heart in the fact that we see many enduring growth trends driving productivity and innovation. These include:
- Corporate investments to support business security and continuity.
- Government support for investments in renewable energy, infrastructure and manufacturing.
- A more flexible and distributed remote work model to expand the labor pool.
- Ongoing enterprise digital transformation.
- A healthy financial sector to ensure capital availability.
- Innovation and investments in technology and tools to drive productivity[4].
Ultimately, we remain confident that well-run, high-quality companies with a capability for sustained long-term growth can outperform over time.
By Keith Lee, CFA, co-chief investment officer, Global Growth Equity
