Wall Street's Warning: Profit Expectations for 2025 Dim

As we approach the midpoint of 2024, Wall Street analysts are revising down their profit forecasts for S&P 500 companies in 2025. This shift in expectations raises concerns among investors about the outlook for corporate earnings and the broader economy. This article explores the reasons behind the downgrades and their potential implications for investors.

Analysts' profit expectations for the S&P 500 in 2025 have been revised down, with estimates now ranging between $272 and $277 per share, a 25% jump from 2023 levels (Morgan Stanley, 2024). However, this optimism may be misplaced, as S&P 500 companies excluding the "Magnificent 7" tech stocks saw operating margins decline in the fourth quarter of 2023. Moreover, only 44% of companies reported higher margins than expected, despite favorable conditions like falling manufacturing costs and a strong U.S. dollar. Analysts have also been revising down their earnings estimates for the first quarter of 2024, with expectations for year-over-year growth now at 4.3% for the S&P 500 overall and -0.65% if the Magnificent 7 are excluded.



The decline in operating margins can be attributed to various factors, including increased input costs, pricing pressures, and geopolitical tensions. Inflation and interest rates have also played a significant role in the decrease of corporate profit margins. As of March 2024, one-year inflation swaps have risen above 2.5%, suggesting some investors expect resurgent inflation (Morgan Stanley, 2024). Higher interest rates, used by the Federal Reserve to cool inflation, can increase borrowing costs for companies and reduce their earnings (U.S. Bank, 2024). These factors, combined with a potential "stagflation" scenario where the economy stalls while inflation persists, may contribute to the decrease in corporate profit margins.

Investors should be concerned about the potential impact of geopolitical tensions and global economic uncertainty on corporate profits in 2025. According to Morgan Stanley, S&P 500 companies, excluding the "Magnificent 7" tech stocks, saw their operating margins decline in the fourth quarter of 2023. Only 44% of companies reported higher margins than expected, the lowest in two years. Analysts have also revised down their earnings estimates for the first quarter of 2024, with expectations for year-over-year earnings growth falling to 4.3% for the S&P 500 overall, and -0.65% if excluding the Magnificent 7.

To hedge against potential margin compression and maintain portfolio growth in the face of lowered profit expectations, investors can diversify into sectors with stable or growing earnings. As discussed in the Morgan Stanley report (Number: 0), sectors like energy, utilities, materials, financials, and health care present opportunities for quality growth investments. Additionally, balancing passive portfolio exposure to market-capitalization-weighted indices with active management can help mitigate risks associated with margin compression.

In conclusion, investors should be aware of the narrowing gap between analysts' forecasts and actual earnings, as well as the potential risks posed by geopolitical tensions and global economic uncertainty. However, they should also remain open to the possibility of earnings surprises in 2025. By diversifying their portfolios and maintaining a balanced approach, investors can navigate the challenges ahead and continue to grow their wealth.