Profit surprises are normalizing - and that may signal a healthier stock market, say Citi strategists

By Nora Redmond

Of the over 88% of S&P 500 companies that have reported third-quarter financial results so far, those that reported beats saw earnings per share at an average of 2.7% above estimates.

The third-quarter financial earnings season has signalled a "new normal" for the market, where results beats aren't quite as stellar as in recent quarters, according to Citigroup.

With over 88% of the S&P 500 having posted results so far, few companies have reported fundamentals below analysts' forecasts, with 84% of those announcing earnings per share above consensus - higher than the five-year average of 78%, per data collected by FactSet. But, on average, those firms reported earnings just 2.6% above estimates, which trails below the five-year average of 7.5%, and far below last year's average of about 23%.

"A 'new normal' for earnings reflects the view that the strong positive surprise dynamics at work over the past year are mostly behind us, with the [artificial-intelligence] trade in particular moving increasingly down a more idiosyncratic path," strategists Scott Chronert and Patrick Galvin at Citigroup, wrote in a note published Thursday.

The analysts said while the breadth of sectors that posted higher-than-anticipated results was encouraging, the magnitude of the beats overall was underwhelming, leading to a fairly muted response in stock prices. Semiconductors SOX was one of the industries that saw some of the most positive surprises, while energy XLE was the largest driver after oil companies reported stellar results as crude prices spiked amid the war in Iran.

For Citigroup, the stability in earnings this quarter is a welcome move, however. Chronert and Galvin noted that macroeconomic or political tailwinds will be required next year to lead to analysts lifting corporate earnings targets.

The analysts said a key risk to positive revisions is the continued high cost of the AI buildout.

"Hyperscaler cash balances are being drawn down, debt issuance is rising quickly, and incremental interest expense drag is building," they said. "Estimates risk moving lower as financing costs and equity dilution surprise relative to consensus estimates."

The issue comes especially as a worry after the Democrats won both the Senate and the House of Representatives in the midterm elections, bringing some uncertainty to the financing of data centers.

The analysts wrote that although AI capital expenditure remained strong in the previous quarter, Wall Street is now expecting its growth to peak, which has weighed on its beneficiaries. But because projections for 2027 and 2028 increased, the analysts argue that the persistence of spending on AI is more important than a small beat in the short-term.

"All in, we continue to characterize the earnings set up as solid, implying that lower valuations on recent pullbacks should be viewed opportunistically for now," the team wrote.

-Nora Redmond

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