5 Things We Learned From the Q1 Earnings Season

The earnings season for the first quarter of 2024 is winding down, and for the most part, the news has been good.

As of Friday, 89% of the roughly 1,300 public companies in the Morningstar US Market Index had delivered their results, and 73% exceeded analyst expectations. With all but a few giants like Walmart WMT and Nvidia NVDA having reported, the index is on track for earnings growth of 4% in the quarter. During the same period last year, growth was just 0.7%.

“In general, I would say things were pretty good,” says David Lefkowitz, head of US equities at UBS Global Wealth Management. “We had a pretty healthy breadth and magnitude of earnings beats.”

Overall, stocks are now up 9.4% for the year. Much of that gain is thanks to the enduring strength of corporate balance sheets. When companies continue to bring in revenue and preserve their margins, stocks rise. “Corporate America has really recovered from the earnings recession at the end of 2022,” says Josh Jamner, investment strategy analyst at ClearBridge Investments, who adds that fears of margin contraction haven’t materialized.

On top of that, analysts say company guidance for the upcoming quarter and the remainder of the year has come in unusually strong. Lefkowitz says that’s “supportive of a bull market” in the months ahead.

With the first quarter nearly in the rearview mirror, here are five key takeaways for investors:

• Big Tech’s artificial intelligence spending spree continues to gain steam.
• Analysts see the potential for earnings growth to broaden beyond Big Tech—a positive for markets.
• Wide performance gaps persist between sectors, indicating that pandemic-era distortions still affect the market.
• Consumers remain healthy, despite concerns about more cautious spending.
• Guidance has been better than expected, bucking the usual trend.

Big Tech’s AI Spending Spree Gains Steam

AI continues to dominate markets, and this cycle was no exception. First-quarter results showed companies continuing to pour money into the technology.

Alphabet GOOGL/GOOG reported $12 billion in spending in this category in the first quarter, up more than 90% from the year-ago period. “The significant year-on-year growth in capex in recent quarters reflects our confidence in the opportunities offered by AI across our business,” Alphabet CIO Ruth Porat said on an earnings call.

Analysts from Bank of America point out that Microsoft MSFT, Amazon AMZN, Alphabet, and Meta Platforms META are expected to spend $193 billion on capex in 2024, up 31% on an annual basis. “Just during this earnings season, their capex has been revised up by $16B,” they wrote last week. They expect all that extra spending to boost other areas of the market, including semiconductor, power, and utility companies.

Earnings Growth Could Broaden Beyond Big Tech

Concerns about an overly concentrated market have persisted for the better part of 18 months, as gains from the market’s largest players—a cohort known as the Magnificent Seven, which includes Nvidia, Meta, Apple AAPL, Amazon, Microsoft, Alphabet, and Tesla TSLA—drove the lion’s share of returns. But this earnings season, analysts see signs that the market’s long-awaited broadening could be around the corner.

“We’re getting in aggregate a little bit of profit growth from companies outside of the Magnificent Seven,” Lefkowitz says. “That should accelerate over the balance of the year.” This rotation is in its very early stages. Right now, the bulk of the earnings growth of the S&P 500 index is still attributable to a handful of mega-cap tech companies, says Jeff Buchbinder, chief equity strategist at LPL Financial.

But moving forward, analysts expect that trend to moderate. “The narrowness of the market was to some degree supported by their superior earnings growth on offer in that handful of companies,” says Jamner. “As we look toward the second half of this year and 2025, there’s a lot of growth outside of those companies.”

Wide Performance Gaps Persist Across Sectors

While earnings results were largely encouraging, analysts say the high-level numbers mask distortions that are more dramatic than in previous years.

“You have some sectors that are growing at a healthy clip, and others that are still seeing earnings contractions,” Jamner says. “That range is much wider” than before the pandemic, he adds.

Jamner attributes the unusually wide performance gaps across sectors to pandemic-era distortions still playing out across the stock market, hitting different industries at different rates. “Tech benefited in March of 2020, whereas hotels clearly did not. But by March of 2022, tech was no longer benefiting, but as stimulus and vaccines came to the fore, hotels were in a very different place,” he explains. “The normal boom/bust cycle and the linkages between sectors have been disrupted.”

This is true even within traditional sector categories that tend to track each other, Jamner explains. Consumer defensive saw 2.5% earnings growth in the first quarter, while healthcare stocks (another traditionally defensive play) saw earnings contract more than 50%.

Jamner expects this phenomenon to unwind in the months ahead: “As we start to think about 2025, [more sectors are] hopefully setting themselves up for a prolonged period of normal-looking expansion as opposed to post-covid, which was supercharged.”

Consumers Remain Healthy

In calls with analysts over the past few weeks, retailers, restaurants, and banks painted pictures of a consumer who’s still healthy, employed, and spending money, despite fears that dwindling pandemic savings and stubborn inflation would finally dent household balance sheets. “Unemployment is very low. Home prices are up. Stock prices are up … higher-income folks still have more money, they’re still spending it. So whatever happens, the customer is in pretty good shape,” JPMorgan CEO Jamie Dimon said on an earnings call.

That’s despite warnings of a potential pullback in spending on the margins. Some analysts see signs of more judicious spending on cheaper goods, especially on the lower end of the income spectrum, as economic headwinds build. “We continue to feel the impact of a more cautious consumer, particularly with our more occasional customer,” Starbucks SBUX CEO Laxman Narasimhan said on an earnings call. McDonald’s MCD executives voiced similar concerns. But overall, Lefkowitz still sees strength. Consumers are “in a good place,” he says.

There’s also reason for optimism in the quarters ahead. “Concerns around potential consumer trade down continue to percolate, but we think manufacturers that enjoy a strong brand portfolio, fostered with sufficient resources to ensure lineups keep pace with evolving consumer trends, should weather any impending storms well,” says Erin Lash, director of consumer sector equity research for Morningstar.

Positive Guidance Buoys Confidence

Earnings reports bring two major signposts for investors: financial results from the previous quarter and guidance about companies’ likely performance in the future. Analysts draft estimates for future earnings growth based on the guidance companies provide, and market pundits often point out that regular downward adjustments to guidance tend to make it easier for firms to exceed expectations. As a result, stocks often get a “surprise” boost on better-than-expected performance.

But strategists say the pattern is different this year. “For the second quarter, we’re seeing the estimates rising a little bit” where they’d usually be falling ahead of the next earnings cycle, Lefkowitz says.

At the end of March, for instance, analysts were expecting 9.6% earnings growth for the S&P 500 index for the second quarter. This week, that estimate rose to 10% growth.

It’s a sign that investors and analysts feel confident about the market’s prospects. “We’re seeing good earnings results, and that momentum looks like it’s carrying forward into the second quarter,” Lefkowitz says.