Under the Hood: Fourth Quarter Earnings Kickoff

JP Morgan kicked off earnings season on Friday as the bank wrapped up its most profitable year ever. While the prospect of lower interest rates in 2024 may temper record profits, the outlook was more optimistic than anticipated. Jamie Dimon, the bank’s Chairman and CEO, acknowledged that the company is over-earning on both interest income and credit, but as these factors normalize, JP Morgan anticipates achieving earnings near record levels once again in 2024. This better than expected outlook supports the Carson Investment Team’s financial sector overweight in the 1^st half 2024 Outlook.

Investors are looking for companies to eke out the second consecutive quarter of year-over-year quarterly earnings growth, following declines that commenced in late 2022. While expectations call for only 1.3% growth in the fourth quarter, analysts expect S&P500 earnings will snap back to a brisk double-digit rate in 2024. Investors will be scrutinizing the full year guidance that many companies give on their fourth quarter update calls for clues that support the optimistic outlook.

Against a backdrop of easing inflation and improving efficiency, a key component of earnings growth in 2024 is expected to come from margin expansion. This healthy margin expansion hinges on operating leverage, rather than simply cost cutting measures. The focus is on identifying companies capable of growing sales at a rate that outpaces expenses. It’s crucial to strike a balance between growth and efficiency, because without growth, achieving margin expansion comes at the expense of deeper cuts that could impact the overall quality of the business. Therefore, a healthy combination of both growth and efficiency will be key for fundamentals to live up to expectations.

The initial glimpse offered by JP Morgan, and peers like Bank of America and Wells Fargo, coupled with commentary from UnitedHealth and Delta, suggest that perhaps the tide isn’t turning as fast as anticipated. The US economy remains resilient, and consumers continue spending. However, inflation may be stickier than initially expected as companies expect wages, fuel prices, and healthcare costs to continue rising in 2024. This narrative aligns with recent economic data that suggests investors may have gotten a bit ahead of themselves on the timing and magnitude of rate cuts.

With only a handful of companies reporting, it’s far too early to draw any meaningful conclusions, particularly from the banks where margin on interest income was already expected to soften this year. Regardless of the path to earnings growth in 2024, initial commentary suggests that demand remains resilient which supports top line growth and thus the first component of operating leverage. I expect the efficiency narrative to gain some steam as other sectors, like technology and communications, offer their outlooks. These important sectors that drive much of our economy have been reducing headcounts and right-sizing operations for some time now and much of that work should bear fruit in the form of margin expansion, and ultimately earnings growth, in 2024.

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