Earnings Revisions Show Stabilization, but Guidance Remains Critical Heading into Q1 Season
2min read Wall Street is bracing for a softer Q1 earnings season, as analysts have slashed S&P 500 profit forecasts since the start of the year. factset reports that estimated Q1 earnings growth now stands at 7.1% year-over-year, down from 11.6% as of December 31. While this still marks the seventh consecutive quarter of earnings growth, it reflects widespread downward revisions across all 11 sectors. The forward 12-month P/E ratio remains elevated at 21.4, highlighting the market’s dependency on future earnings growth to justify valuations. Despite the negative trend in revisions, morgan stanley notes a stabilization in some key areas—particularly among the “Mag 7”—that could help steady market sentiment and position equities for a rebound into earnings season.
The overarching theme in revisions is one of broad caution. According to FactSet, 66 S&P 500 companies have issued negative EPS guidance for Q1, compared to just 39 offering positive outlooks. That 63% negative guidance rate exceeds both the 5-year (57%) and 10-year (62%) averages. At the sector level, materials have been hit hardest, with a staggering 96% of companies seeing lower EPS estimates since December. Earnings expectations for the group fell 16.5% in aggregate, led by double-digit estimate cuts at names like Dow, fmc, and celanese. Consumer discretionary followed, with Tesla and Ford leading the charge lower, while the consumer staples sector saw the third-largest downward move, headlined by guidance reductions from Walmart and Estee Lauder.
Despite these declines, Morgan Stanley sees a silver lining: earnings revision breadth, while still negative, is stabilizing. Most notably, the firm’s analysis shows that Mag 7 earnings revisions have flattened near 0%, suggesting a bottoming process may be underway. This is particularly important given that prior Mag 7 underperformance triggered capital rotation to Europe and other international markets in Q4, exacerbated by a strong U.S. dollar. With the dollar off ~5% from its January highs and mega-cap growth stabilizing, Morgan Stanley believes this could mark the beginning of a reversal in flows back into U.S. equities—particularly in quality growth names.
Ask Aime: How will the lower S&P 500 earnings growth affect the market?
Morgan Stanley has repeatedly emphasized the importance of Mag 7 leadership in sustaining U.S. equity performance. These companies not only represent a significant share of index earnings but also serve as a psychological anchor for growth-oriented investors. Stabilization in their revisions could catalyze relative outperformance into Q1 earnings, especially if guidance is constructive. In Morgan Stanley’s view, renewed strength in the Mag 7 is a necessary condition for reversing outflows and reasserting U.S. equity leadership on a global scale.
While the S&P 500 itself only corrected about 10%, Morgan Stanley notes that many individual stocks—especially in semis, consumer durables, and small caps—experienced drawdowns of 20–30% or more. Over half of the Russell 2000 is down more than 30% from recent highs. Despite this carnage, sentiment has rebounded from extreme lows, and the firm’s proprietary Market Sentiment Indicator, while still below neutral, supports the case for a continued near-term rally.
Valuation remains a key consideration. The forward P/E of 21.4 is above the 5- and 10-year averages, though down from 21.5 at the end of Q4. According to FactSet, the S&P 500 price has declined 3.5% since December 31, while forward EPS estimates have risen 1.8%. This has helped ease valuation pressure somewhat. Still, with revenue growth expected at just 4.2% in Q1 and higher growth expected in later quarters (12.0% EPS growth forecast for Q3), forward guidance in April could prove more important than backward-looking Q1 results.
Ultimately, while the downward trend in revisions has been pronounced, the emerging signs of stabilization—especially in the Mag 7—may be enough to restore market footing. If guidance confirms that Q1 is the trough for earnings momentum, bulls could find justification for higher valuations. But if forward outlooks deteriorate, the already-elevated multiple will be harder to defend. As always, earnings season won’t just be about what companies did—it’ll be about what they say comes next.
