Large caps seeing positive earnings growth across most sectors
Last week, we looked at large caps, and how earnings are starting to broaden out beyond just the Magnificent 7.
We see broad-based earnings gains at the sector level, too (chart below, green bars):
- Communication Services, IT, Utilities, and Consumer Discretionary still boosted by AI
- Financials seeing rebound in trading profits, dealmaking, and IPOs
- Health Care seeing positive earnings growth for first time in two years, now benefitting from comparison against weak earnings a year ago and the popularity of GLP-1 weight loss drugs
Just three sectors are seeing negative earnings growth (red bars):
- Energy remains in earnings recession for 5 quarters, with lower gas prices (down 6% YoY) and refining margins
- Industrials are facing drag from airlines, as excess capacity weighs on fares
- Materials remain in the earnings recession for two years, facing broad-based drag from the earlier manufacturing recession (which is starting to turn around)
Smaller companies are still lagging
While large caps are seeing broad-based strength, mid-caps and especially small caps are seeing broad-based weakness in earnings over the past 12 months:
- Mid-caps earnings are projected to fall 3.5% YoY in Q2 (chart below, blue bar), putting them back in an earnings recession (back-to-back quarters with negative growth).
- About half the sectors see negative earnings growth (IT, Materials, Consumer Discretionary, Financials, and Industrials).
- Small caps are even worse off, stuckin an earnings recession for two years straight, with earnings falling over 17% YoY in Q2 (green bar).
- Nine sectors to see negative earnings growth (only Health Care and Utilities are expected to see positive earnings growth).
As we’ve discussed before, one factor weighing on earnings is that these smaller companies face greater margin pressure from borrowing costs, as they have more floating rate debt (so pay higher interest expense now). In contrast, Large caps were able to lock in long-term, low fixed-rate debt early on the pandemic. In fact, the weighted average rate for large cap debt is just 3.6%, while floating interest rates are over 9% for small companies.
But that’s also why the recent falls in long-term rates have helped small companies outperform (you may have read about a “rotation” out of Mag 7).
Rising earnings reflected in returns too
In the past, we’ve shown that earnings are a key driver of returns. So, with mid-caps and small caps in earnings recessions for much of the last two years, it makes sense that large caps have outperformed them. In fact,
- Large caps: the S&P 500 is up nearly 60% over the last couple years (chart below, solid orange line), setting 38 new record highs this year alone, just as S&P 500 forward earnings has also risen to new record highs (dashed orange line).
- Mid-caps: S&P 400 forward earnings remain below their 2022 record high (dashed blue line), and the S&P 400 price has only just surpassed its 2021 high (solid blue line).
- Small caps: the S&P 600 forward earnings (dashed green line) and price (solid green line) both remain below previous highs. That could also be one reason some smaller companies are still hesitant to IPO.
So, fundamentals (rising earnings) have supported the differences in stock price gains.
The good news is that from here, analysis project to see positive earnings growth in Q3 and Q4 for large and small cap stocks. If that happens, we might see some more record highs, and rotation into small caps, too.
The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED. © 2024. Nasdaq, Inc. All Rights Reserved.