Earnings season will be critical for stocks after rough start to 2024

The mood going into fourth quarter earnings season on Wall Street is "meh."

After a blistering rally to end 2023, stocks have stumbled to begin the new year. Apple (AAPL), a bellwether for market vibes these days, has been downgraded by Wall Street strategists twice in the past week over fears of slowing growth. Bets on a March interest rate cut from the Federal Reserve have tapered.

And analysts have cut their earnings projection for S&P 500 (^GSPC) companies by more than usual heading into the reporting period, which kicks off with big banks on Friday.

Consensus estimates are for S&P 500 earnings to grow 1.3% compared to the same quarter last year, a decline from Q3's near 5% year-over-year growth.

Morgan Stanley chief investment officer Mike Wilson believes fourth quarter results will be a crucial test of investors' belief that the economy will skirt recession as inflation comes down — the so-called soft-landing trade.

"Q4 earnings season should be informative in this respect as it will offer insight into how companies are thinking about the macro backdrop post the Fed's dovish shift," Wilson wrote in a weekly note to clients. "Macro uncertainty has been a key topic of discussion over the past several earnings seasons so it will be critical to see to what extent that uncertainty has subsided post the last FOMC meeting."

While recent signs of a still sound economy have some questioning if that means the Fed will need to be more restrictive with monetary policy, market bulls believe the economic resilience is a welcome sign for earnings.

"We expect S&P 500 firms in aggregate will benefit from continued strong economic growth and subsiding input cost pressures and beat consensus forecasts," Goldman Sachs Chief equity strategist David Kostin wrote in a note to clients on Friday.

Kostin's team places consensus expectations for earnings growth at 3% for the fourth quarter. The analysts highlight that in recent quarters, earnings have beat expectations by an average of four percentage points.

While when taken at large, Goldman's point about earnings usually topping expectations is sound, Evercore ISI's Julian Emanuel provided another reminder to investors: Not everyone is a winner during earnings seasons.

And in the recent market moment, where calls for an economic downturn seem never-ending, signs of weakness in a corporate report have been particularly painful.

Emanuel highlighted recent December reports from Nike (NKE), FedEx (FDX), and Oracle (ORCL). All three saw their stocks fall double digits after disappointing reports. To Emanuel, these examples show stock picking remains crucial ahead of earnings.

"In an uncertain environment where 'Nothing can go wrong' has been priced into stocks, we expect there to be a premium during earnings season for stocks that have proven to be earnings season winners, dependable reporters, quarter in and quarter out over these last two years where both stocks and earnings have essentially come Full Circle since the S&P 500 market peak on 1/4/2022," Emanuel wrote in a Sunday note to clients.

Bank of America believes the fundamentals revealed during the upcoming reporting period will be crucial to the firm's projection that the S&P 500 will end 2024 at 5,000. The firm believes earnings turned a corner in the third quarter and continued on that trend in the fourth quarter.

"Companies have cut costs throughout the earnings recession," BofA equity strategist Ohsung Kwon told Yahoo Finance. "They have managed margins. Margins went up for the second straight quarter. So I think the momentum is to the upside, and if companies talk more positively this earning season, given that the rate pressure and the macro uncertainty has eased somewhat, now that's going to be bullish for equities."

Deutsche Bank chief US equity strategist Binky Chadha sees "big beats" outshining the "pessimistic consensus." In an earnings preview research note, Chadha pointed out that one-off factors like the labor strikes in the auto sector and waning COVID demand in health care contributed to the larger-than-normal downward revision for earnings estimates headed into quarterly reports.

"Outside of these lumpy one-off charges, aggregate estimates have been cut by -3.5%, only slightly worse than the typical cut of -3.0% at this stage of earnings seasons historically," Chadha wrote.

Notably, Chadha highlighted that megacap growth and technology, which drove a significant portion of the 2023 rally, were the only sectors whose expectations weren't revised downward in the past few months.

But even still, Chadha, who has a 5,100 call on the S&P 500 at year-end, has tempered expectations on what a positive fourth quarter earnings season could mean for the benchmark average.

"The size of the equity rally during earnings seasons has historically been tied largely to market performance and equity positioning going in," Chadha explained in a note to clients. "Despite the robust growth and strong beats we expect this season, the market rally is likely to be tempered by the solid run up in the S&P 500 since the end of the previous earnings season and elevated (but not extreme) equity positioning."

Josh Schafer is a reporter for Yahoo Finance.

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