Earnings Growth Stays Positive Despite Slower Demand

Global earnings growth remained positive in the third quarter even as demand showed some signs of weakness.

At the same time, the growth of AI and alternative energy drew more capital spending for electricity generation. This benefited a wide range of companies, from machinery and equipment makers to service providers.

Other earnings highlights from around the globe include:

• The S&P 500^® Index marked its fifth consecutive quarter of year-over-year earnings growth, though it was lower than the previous quarter.¹ Communication services, health care and consumer discretionary reported the most robust growth. The energy, materials, industrials and utilities sectors were weakest.

• Europe saw tepid earnings growth of approximately 4%.² Banks, insurers and financial services generally reported positive earnings growth. Higher interest rates benefited banks, while higher pricing helped insurers. European utilities drew strength from increased power demand related to AI and the rising adoption of renewable energy.

• Japan reported earnings growth of 13.05%.³ IT services and pharma companies reported positive earnings surprises. IT services companies continue to benefit as Japanese companies modernize IT infrastructure and pursue other digitization projects. Conversely, negative earnings stood out in export-focused sectors, with sluggish end-market demand impairing autos and auto parts.

• Earnings from emerging markets were up 11.49%.⁴ The information technology, industrials and materials sectors powered growth. Real estate, energy and health care dragged.

Five Critical Trends Influencing Earnings Growth

1. Demand for AI Infrastructure Boosts Capital Spending

Large cloud computing providers continue to invest in infrastructure to support generative AI initiatives.

Forecasts call for Microsoft, Amazon, Alphabet and Meta to spend $205 billion in 2024, up 46% from last year. These companies are examples of hyperscalers – cloud providers with massive computing resources that can support large and growing demand. See Figure 1. Those four companies alone make up roughly 22% of the overall S&P 500’s spending on capital expenditures. That’s up from 9% five years ago.

The rest of the S&P 500 isn’t expected to boost spending on capital expenditures. On earnings calls, many companies spoke about uncertainty over the outcome of the U.S. election as a reason for pausing or delaying spending decisions in the short term.

2. Mixed Signals in U.S. Consumer Spending Trends

U.S. revenue growth achieved its 16^th consecutive quarter of growth, the best results since the third quarter of 2022.

However, consumer-facing companies report that low-income consumers are under more pressure and have started to change their spending habits. This is reflected in Target’s earnings results. The retailer tied its weaker performance to softer demand for nondiscretionary items, which tend to be more profitable.⁵

We also saw further signs that higher-income consumers are trading down. This was apparent at Walmart, which attributed 75% of its gain in market share to households earning more than $100,000.⁶ Many consumers may have had enough of higher prices and are choosing cheaper private-label products or restaurants where they believe they get better value.

For example, Costco’s earnings release highlighted a shift to eating at home and trading down to lower-cost food.

3. Magnificent Seven Stocks Propel Earnings Growth

The Magnificent Seven stocks – the largest companies in the S&P 500 – saw earnings growth of 18% year over year in the third quarter. Meanwhile, the other 493 companies in the index grew by 2%.⁷

These seven stocks accounted for almost all the earnings growth during the first three quarters of 2024. However, the earnings gap could begin to narrow, according to forecasts for the rest of 2024 and the first couple of quarters of 2025.

The Magnificent Seven’s strong earnings growth has led to significant price appreciation for their stocks compared to the broader market. As shown in Figure 2, their 12-month-forward price-earnings (P/E) multiples diverted from the rest of the index in 2014 and are still elevated today.

However, the Magnificent Seven’s relative valuations are below their 2020 peak as these companies have somewhat “grown into” their valuations. Valuations of non-Magnificent Seven companies are much closer to the historical average of the S&P 500 overall.

4. Weaker Demand Impacts Non-U.S. Market Performance

European companies in consumer-facing sectors, such as luxury goods, encountered sluggish Chinese demand. Richemont, the owner of Cartier and Piaget, reported results below analysts’ expectations, and its chair pointed to weaker demand from China.⁸

Europe’s automakers also faced weakness in global demand, leading to restructuring plans. Volkswagen has announced significant job cuts and plant closures.⁹ Schaeffler, an auto parts manufacturer, plans to cut around 4,700 jobs.¹⁰

Autos and auto parts were a concern for Japan, too, where results were generally attributed to weak demand in the U.S. and increasing incentive costs.

Weaker global economic growth, especially in China, dragged down oil prices, impacting the energy sector.

5. Japanese Companies Pursue Share Buybacks

During the first five months of 2024, companies announced plans to repurchase roughly $57 billion of their stock.¹¹ These buybacks can be traced back to the country’s “three arrows” economic strategy. As part of these growth plans, the government is encouraging companies to improve their corporate governance, which includes returning more value to shareholders.

This represents a shift from recent decades when Japanese companies became more risk-averse because of the 1990s stock market bust. They hoarded cash, and share prices suffered.

The buybacks are a shareholder-friendly move that sends cash to investors, making these stocks more attractive.

Earnings Forecast: A Mixed Bag for the Remainder of 2024

Analysts expect S&P 500 earnings to grow by 11.8% in the fourth quarter as input costs continue to normalize and year-over-year comparisons become easier.¹² Forecasts call for U.S. profits to climb approximately 9% for the 2024 calendar year and 15% in 2025.¹³

However, U.S. policies on tariffs, taxes and government spending could impact those forecasts.

Non-U.S. developed markets have a mixed forecast for earnings growth. European earnings are expected to reach 4.2% in the fourth quarter of 2024 and 2.7% in the first quarter of 2025.¹⁴ For the 2024 calendar year, earnings growth is expected to be 0.61%.¹⁵ Japan could experience slightly negative growth for the quarter but hit 6.58% growth for the calendar year.¹⁶