What Factors Will Drive S&P 500 Performance This Year?

Key Points

• Many investors feel a sense of relief after the broad markets rebounded in the first quarter, driven by strong tech-sector performance.
• Many analysts are forecasting gains in the S&P 500 this year, on the heels of 2022's decline.
• It's unusual to see two downside years in a row, so there is a strong likelihood of a positive return.
• Nonetheless, forecasts may be revised lower along with earnings estimates.
• FactSet notes that companies are revising their own estimates lower, with tech and industrials slashing more than other sectors. 

If there’s one question investors are always pondering, it’s this: Where is the market headed? 

Many investors feel a sense of relief after the broad markets rebounded in the first quarter. Some even have a  growing sense of optimism as index-tracking exchange-traded funds like the SPDR S&P 500 ETF Trust NYSEARCA: SPY, Invesco QQQ ETF NASDAQ: QQQ, and the SPDR Dow Jones Industrial Average ETF Trust NYSEARCA: DIA posted gains.

The best-performing stock that all three indexes have in common is Microsoft Corp. NASDAQ: MSFT, up 28.21% in the past three months. 

The biggest year-to-date S&P gainers are:

• NVIDIA Corporation NASDAQ: NVDA 83.94%
• Meta Platforms Inc. NASDAQ: META 75.74%
• Warner Bros. Discovery Inc. NASDAQ: WBD 56.01%
• Tesla Inc. NASDAQ: TSLA 50.61%
• Align Technology Inc. NASDAQ: ALGN 50.32%
• West Pharmaceutical Services Inc. NYSE: WST 47.34%
• Salesforce Inc. CRM NYSE: CRM 47.30%

Optimistic forecasts abound, including a recent Reuters poll of financial professionals who see the S&P 500 gaining 9.43% this year; brokerage Fidelity, which sees a 10% gain, and researcher FactSet, which found that industry analysts forecast a 17% increase in the S&P 500.   

However, plenty of headwinds, including cuts to earnings estimates, worries about recession and inflation, continued Fed rate hikes, and ways in which bank failures may affect the broader economy are still taking center stage. All of those potential threats loom large even if the markets and the economy are not facing 2008 redux, given that conditions in 2023 differ dramatically from 15 years ago. 

Which brings us to the original question: Where are markets headed this year? 

To review the obvious, if anyone knew, with certainty, he or she certainly wouldn’t share that information. Yet, both professional investors and do-it-yourselfers turn to estimates and forecasts to help with decision-making. 

Nothing wrong with that; all industries peg their models and future plans to existing data, using those to extrapolate future potential. But you can’t really bet the farm on S&P 500 forecasts. In fact, far from always presenting a too-rosy picture, analysts frequently underestimate the growth of an individual stock or the broader market. 

Now that the market has a full quarter behind it, in which the tech sector led the way, estimates are changing, as you’d naturally expect. 

More Companies Issuing Negative Guidance

In an April 6 blog post, FactSet’s John Butters noted that 106 S&P 500 companies had issued EPS guidance for their upcoming first-quarter reports. “This number is above the 5-year average of 97 and above the 10-year average of 98. Of these 106 companies, 78 have issued negative EPS guidance, and 28 have issued positive EPS guidance,” he wrote.

Butters added that the number of companies issuing negative EPS guidance is above the five-year average of 57 and above the 10-year average of 65. Meanwhile, the number of companies issuing positive EPS guidance is below the five-year average of 39 and below the 10-year average of 33.

You can look up companies’ own guidance and compare those against analyst expectations using the MarketBeat Earnings Guidance screener. 

A chart prepared by MarketBeat’s Thomas Hughes illustrates the recent trend of outlooks declining as earnings seasons get underway. That’s something to watch throughout this year. 

Tech Sectory Quandary

There’s also cause for concern because the red-hot tech sector, which is populated with fast growers, is also slashing estimates.

Butters reports that the tech and industrials sectors have the highest number of companies issuing negative EPS guidance for the first quarter at 27 and 16, respectively. 

“Combined, these two sectors account for more than half (43) of all the companies in the S&P 500 issuing negative EPS guidance for the first quarter (78),” he wrote. 

But here again, there’s conflicting news. FactSet is a data aggregator, which is useful when viewing the big picture. But despite companies trying to manage market expectations for the quarter, some outside analysts, including Deutsche Bank, continue to believe tech will be a growth driver within the S&P 500 this year.

With tech constituting 27% of the S&P 500, you can see why its performance can have an outsized effect on the broad market. A blog post by Nationwide Financial noted the significance of a downturn in tech, saying, “The sizable outperformance of tech stocks between 2016 and 2021 created valuations that, in many respects, may not be sustainable in the current interest rate environment.”

As Always, Expect Surprises

Of course, other industries, including banking, could present still more unpleasant surprises as the year goes on. But these uncertainties are precisely why investors get rewarded for taking risks in the stock market. If the outcome of any given time period were certain, there would be absolutely no reason to get rewarded for owning shares. 

It’s unusual to see two back-to-back downside years in the S&P 500, so in that sense, the probability of an upside year seems strong. 

But if you find yourself pegging your investment strategy solely on forecasts, remember the words of the late economist and writer John Kenneth Galbraith, who said, “The only function of economic forecasting is to make astrology look respectable.”