Lower Earnings Forecasts: Market Risks Ahead?

The stock market is at record highs, but declining profit projections for S&P 500 companies suggest a potential pullback is on the horizon.

Wall Street analysts have lowered their 2025 earnings per share (EPS) estimates by 0.5% over the past six months, dropping from $276 in June to $273, according to FactSet. Sales estimates also fell by 0.3% during the same period. The sharper decline in EPS versus sales indicates pressure on profit margins, as fixed costs limit companies’ ability to cut expenses in response to revenue drops.

This trend extends across the S&P 500, excluding the “Magnificent Seven” tech giants—Nvidia, Microsoft, Amazon, Meta, Alphabet, Apple, and Tesla. These seven companies have largely resisted the downturn due to early gains from rising artificial intelligence investment. For the rest of the index, 2025 EPS estimates have fallen 5.5% this year, according to Citi.

The energy and materials sectors have seen the largest cuts, with EPS forecasts down 18% and 6%, respectively. Oil prices have declined as global economic growth slows and production outside OPEC increases. Materials producers, including chemical and steel makers, are similarly affected by weaker demand tied to slowing economic activity. The consumer discretionary sector has also faced a 2.4% drop in earnings estimates, reflecting diminished consumer spending and broader economic challenges.

While downward revisions are typical—historically averaging 6% for the next year’s estimates—this trend is more concerning against the backdrop of a softening economy. Signs of a slowdown include a weaker labor market, easing consumer spending, and persistently high interest rates. Although the Federal Reserve recently lowered rates, they remain far above the near-zero levels seen in 2021, continuing to weigh on growth.

Even if earnings projections stabilize, current forecasts signal trouble for the stock market. Analysts note a strong correlation between earnings revisions and S&P 500 performance. With upward and downward revisions now evenly balanced, compared to a previous trend favoring upward adjustments, valuations appear stretched. At 22.5 times forward earnings, the S&P 500 is trading at its most expensive level in three years.

A correction—a decline of 10% or more—seems increasingly likely. Morgan Stanley estimates that the S&P 500 could fall to around 5,300, a 16% drop from its current level of 6,095. However, the depth of any decline would depend on a specific catalyst, such as disappointing earnings from a major company, unexpected Federal Reserve policy changes, or economic setbacks.

That said, market pullbacks rarely happen without warning. Investors should remain cautious, particularly with economic growth slowing and stock prices increasingly disconnected from earnings fundamentals. As Morgan Stanley’s chief U.S. equity strategist Mike Wilson points out, “There is room for modest valuation compression from current levels.”

In summary, while the market remains elevated, the risk of a meaningful decline is growing. Prepare for potential volatility and don’t be caught off guard by a pullback.