The S&P 500 is Headed for a Year of Declining Profits

The first, second, and third quarters of this year have seen significant developments: persistent inflation, the Federal Reserve raising interest rates, the resumption of student loan payments, fluctuating concerns about a recession, ongoing discussions about AI, and a surge in tech stocks that boosted the S&P 500 Index.

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As we enter the third-quarter corporate earnings reporting season, following a recent stock market pullback and decreasing profit expectations, some observers argue that investors remain overly optimistic. Others suggest that Wall Street is eagerly awaiting a catalyst for a more definitive market move. While worries about a downturn have lessened, concerns about sustained higher costs for consumers and businesses have emerged as the new normal.

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Jay Woods, Chief Global Strategist at Freedom Capital Markets, expressed this sentiment, saying, "They want that next big thing, and we haven't had it. AI was the next big thing. That was the whole story the first half of the year. That story has changed, and now they want to see the results from it."

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According to FactSet, third-quarter per-share profits for the S&P 500 Index's 500 companies are projected to decrease by 0.3%, marking the fourth consecutive quarter of declines. Although the index has gained 12.2% this year, it experienced a retreat in August, largely due to concerns about prolonged higher borrowing costs.

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As JPMorgan Chase & Co and Delta Air Lines Inc. kick off the third-quarter earnings season, investors will gain insight into how these concerns are affecting consumers, following two years of price increases and increased spending. Nike Inc. recently described consumers as "resilient," but Woods cautioned that this resilience might be tested when people start repaying student loans or taking out mortgages at higher interest rates as they move out of their homes.

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Earlier this year, the ambitions surrounding AI drove up the stock prices of companies like Nvidia Corp. and Microsoft Corp., which have the potential to influence broader markets. However, some Wall Street analysts have started scrutinizing the costs of these tech giants' AI investments and their short-term impact on profits.

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Richard Saperstein, Chief Investment Officer at Treasury Partners, anticipates a "solid" earnings season but believes that Wall Street's earnings expectations for the rest of this year and the next are overly optimistic. He also noted that for the market to remain content, many things will need to go well.

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Saperstein stated, "The market right now is priced for perfection, with elevated expectations for a bullish slowdown where the economy slows enough to bring down inflation but not enough to trigger a recession. It is very hard to see how the Fed and the economy will thread this needle, and we believe that markets expect everything to fall into place when it comes to inflation, the economy, and rates, and that is a very high bar."

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