The stock market is trading at record highs, but declining profit projections for S&P 500 companies suggest a pullback may be on the horizon.
Wall Street analysts have revised their 2025 earnings per share (EPS) forecasts downward by 0.5% over the past six months, from $276 in June to $273, according to FactSet. Sales estimates have also dropped, albeit by a smaller 0.3%. This mismatch suggests shrinking profit margins, as EPS projections are falling faster than sales estimates. Fixed costs that remain steady when revenue declines often pressure margins further.
The downward trend in profit projections spans the broader S&P 500, excluding the “Magnificent Seven” (Nvidia, Microsoft, Amazon, Meta Platforms, Alphabet, Apple, and Tesla). These seven companies, which benefit from rising investment in artificial intelligence, have bucked the trend, with their 2025 EPS expectations largely holding up. The other 493 companies in the index, however, have seen their EPS projections for 2025 drop by 5.5% this year, per Citi.
The energy and materials sectors have been hit the hardest. EPS forecasts for these sectors have declined by 18% and 6%, respectively, as oil prices have fallen amid sluggish global economic growth and increased production from non-OPEC nations. Similarly, materials producers like chemical and steel manufacturers are grappling with slowing economic output. The consumer discretionary sector has also faced a 2.4% decline in earnings projections, reflecting weaker consumer spending and broader economic challenges.
While such downward revisions are common—historically averaging 6% for the next year’s projections—this trend is concerning in the context of a weakening economy. Signs of a slowdown include a softening labor market, subdued consumer spending, and high interest rates. Although the Federal Reserve recently cut rates, they remain far above the near-zero levels of 2021, continuing to weigh on economic activity.
Even if revisions stabilize, current profit forecasts raise red flags for the stock market. Morgan Stanley data indicates a strong correlation between earnings revisions and S&P 500 performance. With upward and downward revisions now roughly balanced, a sharp contrast to earlier trends favoring upward adjustments, the S&P 500 appears overvalued. At 22.5 times forward earnings, the index is trading at its most expensive level in three years.
A correction, defined as a decline of 10% or more, seems plausible. Morgan Stanley suggests the S&P 500 could drop to around 5,300, representing a 16% decline from its current level of 6,095. However, the extent of any drawdown would likely depend on a catalyst, such as disappointing earnings from a major company, shifts in Federal Reserve policy, or broader economic setbacks.
Despite these risks, stock market corrections are typically not sudden. Investors should prepare for potential volatility, especially given slowing economic growth and the disconnect between stock prices and earnings fundamentals. As Morgan Stanley’s chief U.S. equity strategist Mike Wilson notes, “We do see scope for very modest valuation compression relative to current levels.” In simpler terms, stocks may have more room to fall before stabilizing.
Be mindful: while markets remain elevated, the possibility of a pullback is increasingly evident.
