First quarter earnings season kicks off this week with several big banks reporting this Friday, including sector bellwether JPMorgan Chase (JPM). This quarter will seem quite similar to the fourth in terms of growth and drivers, with mega cap technology leading the way. But importantly, the point when the “493” will start contributing to overall profits is drawing closer (the 493 refers to the S&P 500 minus the seven mega cap technology stocks). Here we preview the first quarter earnings season, which will benefit from an improving economic environment and continued strength in technology.

Most of the data is consistent with a resilient U.S. economy. Since the start of this year, Bloomberg-tracked consensus gross domestic product (GDP) growth has increased from 0.5% to 2.0%. The manufacturing Purchasing Managers’ Index (PMI) from the Institute for Supply Management (ISM) jumped from 47.1 in December to a mildly expansionary 50.3 in March (highest since September 2022). The widely followed Citigroup Economic Surprise Index jumped from a slightly negative reading in January (-2.4) to a solidly positive 39 on April 1 (no foolin’). And some green shoots are emerging in Europe and China.

 Also, consider that sticky inflation supports revenue (inflation is pricing power). Revenue grew 4% year-over-year in the fourth quarter and may match that in Q1. Some inflation also helped via higher commodity prices, as West Texas Intermediate (WTI) crude oil jumped 17% during the quarter and copper rose 3.5%, which should help mitigate earnings declines for the natural resources sectors — though offset some by the double-digit decline in natural gas prices. Artificial intelligence (AI) investments will provide a tailwind again.

But it won’t be easy. The biggest challenge may be the strong U.S. dollar, which rose nearly 3% during the first quarter and will clip non-U.S. earnings. Other challenges include wage pressures, the cumulative effects of inflation and rising interest rates on consumers’ spending power, shipping disruptions from the Baltimore bridge collapse (though late in the quarter on March 26), and the increasing difficulty exceeding expectations as the economic cycle matures.

Putting all of this together, our best guess is about 3% upside and 6% earnings growth. During the reporting season, we’ll be watching the ramp in earnings growth reflected in current estimates to identify any movement. A material move downward could remove valuation support for stocks and be a catalyst for a pullback — though likely a modest one that we would expect to be bought based on the supportive macro backdrop.

The economic environment and AI investment remain supportive of corporate profits, so the downside surprises this earnings season seem unlikely. Expectations for economic growth have firmed recently while earnings estimates have remained steady, an indication that the bar is not too high or too low. The big tech companies will generate strong profit growth again, while the rest of the market, the so-called “493”, is moving in the right direction.

Bottom line, expect corporate America to produce typical upside relative to expectations in the quarter and deliver S&P 500 earnings growth of around 6%. Estimate cuts are probably not in the cards, though currency headwinds may temper companies’ outlooks a bit.

~Mark and Elise

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