As 3Q Earnings Beats Shrink, Does the S&P 500 Have Room to Run?

Investors and traders set a high bar for third quarter earnings, and even companies topping expectations got punished for any sign of weakness. 

In fact, earnings "beats" are the smallest in years: in aggregate, companies in the S&P 500 are reporting earnings just 2.7% above estimates, well below the 5-year average of 7.5% and the 10-year average of 8.0%, according to FactSet. If this holds, it will be the lowest earnings surprise percentage since the fourth quarter of 2022. 

The good news? The S&P 500 is up nearly 10% year to date, including this week’s jump of nearly 2%, through Tuesday’s close. And, with 88% of S&P 500 companies having reported results as of Nov. 6, it looks like this will be the third straight quarter of earnings growth above 25%, and earnings growth is positive across sectors. Earnings growth is shaping up to be 31.4% this quarter, and analysts are projecting 4Q earnings growth of 28.4%.

Strongest 3Q S&P 500 Earnings: Energy and Technology 

Of companies that have reported, 84% produced earnings per share above estimates, ahead of the five-year average by 6 points. And 74% beat revenue estimates, 4 points above the five-year average. Earnings beats have been strongest in the S&P 500 Energy and Information Technology. 

The fourth quarter is likely to bring a higher cost to doing business. The probability that the Federal Open Market Committee (FOMC) raises rates Dec. 9 appears likely at this time, according to the CME FedWatch tool, with an 85% chance of a 25-basis-point hike, and a 15% probability of 50 pts. On Tuesday, Fed Governor Christopher Waller said the possibility of a 50-basis-point hike needs to be discussed as the Fed seeks to stem the impact of persistently rising inflation. The October Consumer Price Index (CPI) released Tuesday rose 0.4% month over month, a reading that was hotter than the 0.3% economists expected. See Hot CPI Raises Fed's Rate Hike Chances, Helps Mag 7 Muscle Out Small Competitors 

Will Interest Rate Hike Impact S&P 500 Valuation? 

Corporate balance sheets and cash flow profiles are going to come under greater scrutiny, and that will be especially true for companies tied to the artificial intelligence trade and the AI infrastructure buildout. If earnings continue to climb faster than stock prices, will the market have room to run?  

For now, this seems to be the punchline: The S&P 500 forward 12-month price-to-earnings (P/E) ratio for the index stands at about 17.7, which is a discount to its 5-year average of 19.8, as of Nov. 5, according to FactSet. The challenge is to discern where individual equity valuations pose the greatest risk to performance, with a keen eye on the changing of the guard in Washington.

This material is intended for informational purposes only and should not be considered a personalized recommendation or investment advice. Investors should review investment strategies for their own particular situations before making any decisions.

Schwab Network is brought to you by Charles Schwab Media Productions Company (“CSMPC”). CSMPC is a subsidiary of The Charles Schwab Corporation and is not a financial advisor, registered investment advisor, broker-dealer, futures commission merchant, or forex dealer member.

Charles Schwab Media Productions Company and all third parties mentioned are separate and unaffiliated, and are not responsible for one another's policies, services or opinions.

Data contained herein is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. All events and times listed are subject to change without notice.