News & Insights

S&P 500 Earnings Belie Year-To-Date Market Returns 

The fourth-quarter earnings season for S&P 500 companies delivered a significant upside surprise. With 97% of companies reporting, year-on-year earnings growth was a robust 18.2%, marking the strongest growth rate since the fourth quarter of 2022. The average beat on earnings estimates was a very strong 7.5%. The financial sector led the charge, exceeding expectations by a particularly wide margin.

The improvement stems primarily from enhanced margins and earnings, suggesting companies are effectively managing costs and successfully passing on price increases. Operating margins reached 12.6%, up from 12.2% in the previous quarter and 11.3% a year ago.

The outlook for 2025 and 2026 remains positive, with analysts projecting earnings growth of 12% and 14%, respectively. While the forecasts are strong, they have been revised down significantly since the beginning of the year. Though it is common for forecasts to be tempered early in the year, they have been revised down 3.5% so far, which is more than the long-term average. While analyst forecasts have been strong, corporate management’s guidance has been comparatively muted, which has been historically typical of the beginning of the year. This is traditionally a weaker period for guidance.

Companies are optimistic as reflected by Bank of America's corporate sentiment tracker, currently at an all-time high. Economic improvement, potential deregulation and associated incentives bolster the long-term view.

S&P 500 2025 Bottom-Up Earnings Per Share Consensus Estimates 

Source: FactSet

S&P 500 Bottom-Up EPS Estimates

Source: FactSet

Taming Pandemic Deficits 

For the first four months of fiscal 2025, the federal budget deficit reached the largest amount in history. Research shows that runaway government spending was the most significant contributor to the spike in inflation after the pandemic, feeding into higher interest rates.

The Trump administration began aggressively, with the Department of Government Efficiency (DOGE), conducting audits of each executive branch department. Current budget proposals in Congress anticipate spending cuts of $2 trillion over 10 years in addition to changes that DOGE may recommend. Reduction in the size of the federal workforce, with announced cuts totaling some 300,000 positions thus far, could also significantly reduce spending. Last year, the Government Accountability Office, Congress’ independent oversight agency, estimated that fraud costs the government $233 billion to $521 billion annually.

Reducing the deficit and making headway on total government indebtedness remains challenging. The anticipated extension of the expiring 2018 Tax Cuts and Jobs Act will cost $4.5 trillion over 10 years, which will need to be offset by spending cuts and faster economic growth. In pursuit of a more manageable deficit, a ‘Goldilocks’ outcome would require a combination of higher corporate investment, including international capital, boosted by tariffs and broad deregulation. This would boost growth and productivity, particularly if savings and resources from cuts in federal spending are redeployed into productive uses in the private sector.

US Budget Deficit as a Percentage of GDP vs. Unemployment Rate 

Source: Bloomberg

Cumulative Fiscal Budget Deficit ($BN)

Source: U.S. Treasury Department

DAX Disconnect: A German Enigma 

The German DAX index seems to be defying gravity, outperforming the S&P 500 by more than 10% year to date. The year started with software giant SAP driving a large part of that performance. The company was rewarded for aggressively integrating AI across its entire product line. Though the S&P 500 is highly concentrated, the DAX is even more so, making it less representative of the German economy. Despite valuation concerns regarding the U.S. tech sector, the DAX’s tech sector is even more expensive.

SAP has recently sold off, but German stocks have continued moving higher. This divergence is puzzling given their struggling economy. Growth is anemic, plagued by soaring energy costs crippling the manufacturing sector. The current economic climate would not seem to support a “bull market.” Even as the leader of the CDU/CSU political party struggles to put together a ruling coalition, the market has become enthused by calls for large amounts of deficit spending on defense and infrastructure, casting aside a history of fiscal restraint.

Typical of German politics, the process of implementation is likely to be cumbersome, making the success of the stimulus statement becoming reality far from a sure thing. Until significant corporate and regulatory reforms address the underlying economic issues, and exorbitant energy costs are resolved, the DAX rally's sustainability remains questionable. The reintroduction of cheap Russian natural gas following an end to the Ukrainian war may not happen fast enough to sustain the bullish sentiment of German investors.

German IT MSCI P/E vs. American IT MSCI P/E

Source: Bloomberg

About Frost Investment Advisors, LLC

Frost Investment Advisors, LLC, a wholly owned subsidiary of Frost Bank, one of the oldest and largest Texas-based banking organizations, offers a family of mutual funds to institutional and retail investors. The firm has offered institutional and retail shares since 2008.

Frost Investment Advisors' (FIA) family of funds provides clients with diversification by offering separate funds for equity and fixed income strategies. Registered with the SEC in January 2008, FIA manages more than $5.2 billion in mutual fund assets and provides investment advisory services to institutional and high-net-worth clients, Frost Bank, and Frost Investment Advisors’ affiliates. As of Feb. 28, 2025, the firm has $4.7 billion in assets under management, including the mutual fund assets referenced above.

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This commentary is as of March 14, 2025, for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged, and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable.

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