Earnings vs. rate cuts: Who’s the boss?

If you look back at market commentary over the past year, you would think the only thing that drives the direction of stocks is the Federal Reserve and its plans for interest rates. Commentaries also mentioned the latest economic data, but insofar as the data supports or doesn’t support a rate cut. And when geopolitics was mentioned, there was some tie to, you guessed it, the Fed’s rate policy.

Newsflash: Interest rates are just one driver of stocks. When you buy stocks, you’re not buying into an interest rate (that’s bonds), you’re buying into a company’s future earnings stream. That’s why stock valuations are driven by corporate profit growth. Over time and over interest rate cycles, it’s a company’s earnings growth that will determine the long-term direction of its stock.

Now that we have reaffirmed the paramount importance of corporate earnings as a stock market driver, let’s also remember that we get a front row seat into corporate earnings performance on a quarterly basis. In fact, the market is in the throes of the third quarter reporting period right now. So how are corporate earnings faring? The answer is solidly.

On a year-over-year basis, the companies in the S&P 500 are reporting earnings growth for the fifth-straight quarter. Of these companies, 75% have reported earnings per share above Wall Street analysts’ consensus estimates.

We’ve seen rate cut speculation move the market, but few things can affect an individual stock’s price like an earnings release. Tesla shares rose 22% the day after it reported a 17% rise in profits and said it expected up to a 30% increase in 2025 car sales.

Which companies and industries will have the best earnings growth in the upcoming quarters? Hard to predict. After all, three quarters of the S&P 500 companies beat estimates so far this earnings season. That’s a reason we believe in diversifying equity allocations in our portfolios across thousands of company stocks and all industries.

Today’s stock prices reflect expectations around the future earnings streams of companies. For that reason, it’s important to note that Wall Street analysts currently expect earnings per share for the S&P 500 companies to grow, in aggregate, by 14% in 2025 over this year.

That’s not to say that even solid earnings reports can’t potentially lead to volatility.

The reason being is markets expect key companies such as Nvidia, Amazon and Meta Platforms (Facebook) to increase their earnings at levels well above the average member of the S&P 500. In fact, current estimates have those firms growing earnings 20% to 35% annually over the next few years. Earnings growth that would be considered good for other companies won’t be enough for those leaders, and future results that don’t meet those lofty expectations could rattle markets.

Just the same, 14% aggregate earnings growth estimated for America’s largest stocks means their profit streams – the reason we take on the risk of investing in stocks – is projected to remain intact.

So, the next time you’re faced with headlines on geopolitical turbulence or talk of whether the Fed will or won’t cut rates, remember the stock market’s key pillar is on solid ground.

This article is for informational and educational purposes only and does not constitute an offer, solicitation or advertisement with respect to the purchase or sale of any security. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results.