Despite the concern of higher for longer interest rates, first-quarter earnings are running 5.6% above the same period a year ago. About 78% of companies reporting first-quarter earnings are beating estimates, and they are beating those estimates by an unusually wide margin: 9.5%, well above the long-term average of 4.2% and average of 7% for the prior four quarters. Companies that have had notable earnings beats include Alphabet, Meta and Netflix in the communication services sector; Goldman Sachs, JPMorgan Chase and Morgan Stanley in financials; GE Aerospace and Caterpillar in industrials; and Microsoft in technology. Most importantly: No matter how far out you look, the still-strong economy and strong jobs market is continuing to support earnings. S & P 500 earnings expectations Q2: up 10.9% (uptrend) Q3: up 8.8% (uptrend) Q4: up 14.9% (uptrend) Source: LSEG Resilient consumer is the key The good news: most companies continue to beat estimates and the vast majority have affirmed their 2024 earnings guidance. A few, including Merck, Ford, Chipotle, Waste Management, and Royal Caribbean, have raised guidance. Earnings have been holding up largely because the consumer remains resilient. “Consumer spend across all segments from low to high spend has remained relatively stable. Our data does not indicate any meaningful behavior change across consumer segments,” Visa’s CFO Christopher Suh said. American Express’ CEO Stephen Squeri echoed that sentiment, noting that “consumer spending is relatively strong.” Another key to profits holding up: net profit margins remain high at roughly 11.5%. This is the percentage of profit a company produces from its total revenue. Importantly, the analyst community believes net profit margins will be above 12% for the remaining three quarters of the year, according to FactSet. Valuations coming down So if earnings are up, why is the S & P off its highs? The simple answer is, the multiple (P/E ratio) is contracting. The multiple is what investors are willing to pay for a future stream of cash flow. That future stream of earnings and dividends could stay the same, but when rates go up investor risk appetite gets dampened and they are typically willing to pay less for that future stream At its peak at the end of April, the S & P 500 P/E ratio for 2024 earnings was about 21.6, high by historic levels. Today, a month later, 2024 earnings estimates are essentially the same but the multiple has declined to 20.8. What could be the catalyst for a decline in earnings? If the consumer starts really getting hit. Recall what happened in October of last year. Ten-year yields kept rising, at one point passing 5% (it hit 5.02% on an intraday basis on Oct. 23). That 5% level seemed to be a trigger point. The markets took a dive. The S & P 500 hit a low of 4,117 on Oct. 27 and only recovered when rates came down in early November. Higher oil prices helping earnings The first quarter is over, so what matters now is the perception on earnings for the rest of the year. One reason second-quarter estimates for the S & P 500 have been rising is oil profits are expected to be higher, which have benefited from a spike in oil prices. Energy companies (change in Q2 estimates since March 29) Marathon Petroleum up 51% Apache up 30% Valero Energy up 26% Hess up 19% Marathon Oil up 18% Occidental Petroleum up 13% Devon Energy up 13% ConocoPhillips up 10% EOG up 10% Exxon Mobil up 10% Source: Earnings Scout “While raised estimates are generally positive, it’s worth noting that most of this improvement is coming from Energy companies due to increased geopolitical risk,” Nick Raich from Earnings Scout said in a recent report to clients. There are some big drags on earnings Some companies are seeing large declines in earnings estimates that are weighing on their sectors. Bristol Myers Squibb, for example, is taking an approximately $12 billion one-time charge related to its acquisition of Karuna Therapeutics. When including this one-time item, the S & P 500 earnings growth rate for the first quarter declines to 5.6%, from 8.7%, LSEG has noted. For the second quarter, estimates for the industrials sector have come down significantly because one of the largest companies in the sector, Boeing, has seen Q2 estimates collapse in the last month, going from an expected gain of 64 cents on March 28 to a loss of 66 cents. Tesla’s earnings expectations have also weighed on the consumer discretionary sector, going from an expectation of a 70-cent for the second quarter at the end of March to 60 cents today. Earnings estimates for big-cap tech such as Nvidia, Amazon, Alphabet, Microsoft, Meta, Salesforce and AMD have been stable to rising for the second quarter. The lone exception is Apple, where earnings have drifted lower by a penny, from $1.51 to $1.50. No recession anticipated The market is positioned for a still-strong jobs market and a slowing but still-strong consumer. Profit margins are expected to remain resilient. While there have been some concerns expressed about the consumer, most of the corporate commentary has emphasized resilience: Tractor Supply: “Our customer base remains healthy and engaged,” CEO Hal Lawton noted. Chipotle: CEO Brian Niccol told CNBC’s Kate Rogers that the company is “not seeing any” consumer pullback. D.R. Horton: CEO Paul Romanowski said, “Homebuyer demand during the spring selling season thus far has been good despite continued affordability challenges.” Kimberly-Clark: CEO Michael Hsu commented, “I would characterize the consumer environment overall for us globally, but especially in North America, as resilient.”