Wall Street’s trajectory for the upcoming third-quarter earnings season appears cautiously optimistic, as analysts at Goldman Sachs suggest that expectations have been set too low. David Kostin, the firm’s lead U.S. equities analyst, believes this misjudgment could create an opportunity for stocks to rally, particularly as the majority of S&P 500 companies prepare to release their earnings reports later this month.
Throughout the third quarter, analysts have incrementally raised their earnings estimates, marking the first instance of heightened optimism since late 2021. This trend might lead investors to anticipate positive surprises in earnings reports.
Currently, the consensus estimate indicates S&P 500 earnings growth is projected to slow to 6% in the third quarter, down from 11% in the previous quarter. However, Kostin argues that actual earnings growth could exceed this projection due to unexpectedly strong sales and positive performances from a group of major tech companies referred to as the “Magnificent 7.”
The importance of this earnings season lies in the fact that stock prices are intricately tied to earnings growth and valuation. Given that stocks are nearing record highs and their valuations are elevated, companies are under pressure to deliver solid earnings results to justify their stock prices. A series of better-than-expected earnings outcomes could sustain market momentum as the year comes to a close—a period that is historically favorable for stocks.
Despite projections of a slowing sales growth to 1% from 2.5% in the previous quarter, Kostin contends that this assessment may be overly pessimistic. Supporting his perspective, Goldman economists estimate a GDP growth rate of around 2% for the third quarter, consistent with the second quarter’s performance. If sales growth does underperform expectations, it could be linked to unfavorable foreign exchange rates. The U.S. dollar depreciated in the first half of the year, which had boosted the international sales figures for S&P 500 companies. However, as the dollar stabilized in the third quarter, that advantage likely diminished.
Kostin also emphasizes that the potential of the “Magnificent 7”—which comprises seven major tech companies—has been underestimated. These companies have been pivotal in driving earnings growth for the S&P 500 over recent years. Despite analysts projecting that the group’s earnings will grow at a slower rate in this quarter compared to the last, Kostin points out that similar predictions were made previously, and the Magnificent 7 outperformed those expectations.
Another noteworthy trend is the recent increase in earnings estimates. According to FactSet Research, analysts collectively raised their S&P 500 earnings per share estimates by 0.1% from the start to the end of the third quarter, signaling a newfound confidence not seen since the fourth quarter of 2021. This positive sentiment followed a series of beneficial trade deals and strong financial results that alleviated uncertainties surrounding tariffs. However, Kostin cautions against expecting a repeat of this aggressive upward adjustment this month, given the lack of significant changes in the economic outlook or tariff policies.
He also warns that tariffs will likely create challenges this quarter, with duties reaching $93 billion—a 33% increase from the previous quarter. While companies have managed to maintain stable profit margins through tactics such as supplier adjustments and cost containment, substantial margin growth in the third quarter may prove elusive.
In summary, as investors gear up for the third-quarter earnings reports, the prevailing sentiment reflects cautious optimism. Many expect earnings growth to surpass current projections, particularly bolstered by the strong performances of significant tech companies, all set against a backdrop of a resilient economy.
