Charts of the Month

CHART 1 – A CHEERY EARNINGS CONSENSUS

The chart below shows consensus earnings expectations for companies in the S&P 500, the main driver of global stock markets.

Forecast earnings growth just shy of 10% in 2025 is expected to be followed by nearly 14% growth in both 2026 and 2027. Such an achievement would be impressive, given a long-term growth rate typically closer to 7%, and it explains an important part of the market’s current enthusiasm.

Where will that growth come from? The Magnificent Seven accounted for more than half of US earnings growth last year, but that falls to under 40% this year and less than 30% next. It is improvement in non-tech companies’ earnings, such as financials, that are forecast to drive markets higher from here. A substantial portion of this earnings growth is expected to be down to margin expansion. Given the already hefty margins achieved by the Mag 7 it is not surprising that their overall contribution is expected to diminish.

The laggard? Energy, where earnings are expected to fall nearly 25% due to lower oil prices and a continuation of the weak environment for commodities.

CHART 2 – IS THE EXPECTED MARGIN EXPANSION LIKELY?

The chart below shows US corporate profits as a percentage of GDP in the period since World War II.

Whilst there has been significant variation over time, the current level of profitability is already high at around 13%. Of course, margins may improve even further from here, but what the chart tells you is that a lot is already expected from the AI productivity miracle.

Maybe companies will be able to do more with fewer expensive workers. However, how likely is a further margin expansion with Governments looking to plug their gaping deficits with higher tax takes from both companies and individuals, wages generally on the rise, and de-globalisation/protectionism/on-shoring all gathering pace? Moreover, how sustainable is any margin expansion likely to be?

CHART 3 – ARE EARNINGS GROWTH AND MARGIN EXPANSION REFLECTED IN CURRENT VALUATIONS?

Do current equity valuations reflect an overly-optimistic outlook?

The chart below suggests much of the good news is already priced in, at least if the period from 1985-2025 is anything to go by. The current PE ratio, indicated by the slim grey bar, implies that US stock market returns over the next decade will be muted.

Companies have a lot to live up to, whilst markets also have to believe that even more good news is in the pipeline, if returns are to turn out attractive from here.

Of course, that may well prove to be the case, especially if the AI transformation delivers as promised.

However, this all suggests we should temper some of the current enthusiasm (or FOMO) and think carefully about the outcome if reality ends up falling short of current expectations.

CHART 4 – IT IS IMPORTANT TO AVOID A RECESSION

Heady earnings growth, toppy profit margins and a relatively expensive US equity market all need the outlook to remain rosy.

So far, so good, with inflation largely under control and the potential for rate cuts to ease both the cost of living burden for consumers and the refinancing challenge for businesses.

Of course, the tricky part is timing it right, so that inflation is not only tamed but a recession is also avoided.

The chart below shows the performance of the S&P 500 from 1990, with recessions highlighted by the grey bars. If the central bankers (and increasingly, politicians) do get it right, all will be well. If not, then the unemployment rate will start to rise, at which point some of the market’s current expectations will need re-adjusting.