There will be a little more volatility than normal as 2024 comes to a close, but the overall trend remains upward. To everyone who stops me on the street and asks me, “Why is the stock market going up so much?” I have a pretty simple answer: It’s because overall profits and margins remain at near-record levels. If people continue to ask, “Why is Nvidia up over 180% this year?”, the answer is simple: that’s because Nvidia (and Broadcom) are where profits are growing significantly. The direction of profits is the most important determinant of whether a stock will rise or fall. Stocks are investment vehicles that participate in future cash flows, whether in the form of retained earnings, dividends, or buybacks. The most important factor is the direction of revenue: Is revenue growing or shrinking? How many? Investors may be willing to pay more if they are confident that profits will grow in the foreseeable future (one to two years, really). This is why “growth” stocks have higher price-to-earnings ratios than “value” stocks that don’t have stronger growth prospects. Investors are paying attention to the direction of profit growth. The S&P 500 Index is expected to have overall profit growth of about 10% this year, marking the fourth year of profit growth. Earnings are also expected to grow next year. S&P 500 earnings growth: 2021: 52% growth 2022: 4.8% growth 2023: 4.1% growth 2024: 10.2% growth (expected) 2025: 14.3% growth (expected) Source: LSEG More important The thing is, corporate America still retains a large portion of its profits relative to its revenue. S&P 500 net profit margin (the percentage of revenue that is still profit after deducting all fees, taxes and costs) is expected to be 12.0% in 2024, near an all-time high and above the 10-year average. . Tech stocks have been winning because that’s where profits are growing. Because of the story of artificial intelligence, it has become an investment paradigm, just like the Internet was in the late 1990s. S&P 500 Tech Earnings Growth: 2021: 37.3% 2022: Flat 2023: 9.1% 2024: 20.1% (expected) 2025: 21.1% (expected) Source: LSEG Unfortunately , because “tech” companies are spread across multiple industries, and because the largest companies have become so large, using industry is no longer as useful as it once was when considering earnings growth. Consider this: Tech giants Tesla and Amazon are in the consumer discretionary space, while Meta Platforms, Netflix and Alphabet are in the communications services space. In addition, there are eight companies valued at US$1 trillion, with a total value of nearly US$20 trillion. That’s why the Big Seven is a better representation of large-cap tech stocks than the S&P Tech. Earnings growth for big tech companies is slowing, but it’s unclear whether investors will buy into the rest of the market. . Using the “Seven Wonders” as a proxy for large-cap tech stocks, you can see the dominance of these names based on earnings prospects: Mag 7 Earnings vs. Rest of the Market (2024) “Seven Wonders”: Up 33% S&P Rest ( 493 stocks): Growth 4% Source: FactSet Earnings growth rates for the Big Seven are expected to remain strong, but are expected to slow in 2025. Q4: 18% growth Source: HSBC Private Bank & Wealth Meanwhile, expectations for the other 493 stocks are expected to rise, particularly in the second half of the year. S&P 500: Lowest 493 stocks Forecast for Q4 2024: Up 4% Forecast for Q4 2025: Up 14% Source: HSBC Private Banking & Wealth This has once again sparked excitement among the “rotation” crowd, who Hopefully the other 493 stocks will eventually see earnings improve enough to lure investors away from highly valued large-cap tech stocks and into other areas of the market. How can we get investors out of big tech stocks? I’m skeptical of this rotation hope for two reasons. First, while profit growth for all big tech stocks except Apple and Broadcom is expected to slow next year, these companies’ earnings growth will still be the envy of most other companies. Big Tech Earnings Growth: 2024 vs. 2025 (Calendar Years) 2024 2025 Nvidia 127.6% 50.0% (Fiscal Year Ended January) Amazon 77.1% 20.5% Meta Platform 51.9% 12.1% Alphabet 38.0% 11.25% 112.com % Microsoft 11.5% 10.9% Apple 7.9% 10.8% Source: LSEG/CNBC Broadcom’s profit is expected to grow by 25.3% next year. Nvidia’s profits are expected to grow 50%, while Amazon’s profits are expected to grow 20%. You could argue that Alphabet’s earnings are expected to grow 11.9%, below the S&P 500’s 15% expected earnings growth, and the same goes for Microsoft and Apple. But that’s only because huge gains from Broadcom, Nvidia and Amazon drove that number. Second, the rest of the market hasn’t exactly raised profit expectations. Take a look at the one-year estimates above for the other 493 stocks: up 14%, compared with gains for the quarter of 4%. When investors are used to talking about Nvidia’s 127% earnings growth, 10% growth wouldn’t set the world alight, would it? You can make all kinds of arguments that these companies’ valuation (P/E) increases are too aggressive, but I still think investors would be very happy with more modest increases, even if P/E ratios decline. For example, what if Nvidia has a bad year in 2025? What if the stock only rose 5% in a year when the S&P 500 fell 5%? Even if Nvidia’s profits are still up 50%, will there be a massive sell-off? The P/E ratio will clearly fall, but will investors abandon it? I doubt it, unless the AI story completely breaks down. 2025: Many variables The new year is more volatile than many imagine. Granted, the incoming Trump administration is very business-friendly and is getting a very strong handover: a strong economy and still-growing corporate profits. But we really don’t know what the Fed will ultimately do. As inflation continues, the market has priced in expectations that the Fed will slow down its easing policy. For example, Tom Lee, head of research at Fundstrat Global Advisors, remains bullish on 2025, but noted that there could be at least two “policy mistakes” in 2025 that could impact earnings and the economy. First, he noted that the Trump administration could enact tariffs that would harm the economy. Second, the Fed may be too focused on fighting inflation again, leading to labor market weakness. Bottom line: There are still many potential landmines out there.
Tech stocks rule 2024. | Real Time Headlines
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