Wall Street analysts are currently making significant adjustments to their forecasts for Corporate America's earnings growth in the upcoming year. This shift could have a substantial impact on the already blistering stock market rally. According to data compiled by Bloomberg Intelligence, a key indicator known as earnings-revision momentum has slumped into negative territory and is hovering near its second-worst reading in the past year. This indicates a change in sentiment regarding expected per-share earnings over the next 12 months for the S&P 500.

Corporate Earnings: The Cornerstone of the Stock Market Rally

For most of the past decade, corporate earnings have been the driving force behind the stock market's rally. However, the souring outlook on profit growth may pose a challenge to the S&P 500's further advance. After this year's run, valuations have become stretched and positioning is elevated. The benchmark is on track for its second consecutive year of gains, rising more than 20%, and is currently at its most expensive level since April 2021.Gina Martin Adams, chief equity strategist at BI, believes that stocks are "set up for a reversal." The big issue heading into 2025 is whether the Fed will be able to continue easing policy and if earnings momentum will favor laggards outside of Big Tech.

Third-Quarter Earnings: A Glimmer of Hope

Despite the overall concerns, analysts still expect the S&P 500 to deliver its second-best period of profit growth since early 2022 in the third quarter. As earnings broaden beyond Big Tech, S&P 500 profits are projected to climb by 8.5% through September from a year ago, double the 4.2% estimate at the start of earnings season. With roughly 90% of companies in the index having already reported, the outlook seems promising.However, even with this growth, analysts have marked down EPS estimates for the next 12 months. Executives have delivered mixed outlooks or held back on offering guidance due to uncertainty over Federal Reserve interest-rate cuts, weakness in China's economy, and questions about fiscal policy in Washington.

Energy and Materials Companies: Feeling the Heat

Since mid-October, analysts have lowered year-ahead projections by the most for energy and materials companies as crude prices slump. BI data shows this trend clearly. Excluding energy, which was skewed by lower commodity prices and ebbing inflation, S&P 500 earnings are forecast to grow by about 11% year-over-year in the third quarter.This highlights the challenges faced by these sectors and the potential impact on the overall market. Companies will need to navigate these uncertainties and post sturdy profit growth to sustain and justify the rich valuations that have propelled the S&P 500 above the 6,000 milestone in recent months.

Valuations and the Road Ahead

At 22 times future 12-month earnings estimates, the S&P 500's valuation is well above its long-term average of 18.4 over the past decade. This raises questions about the sustainability of the current rally. Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors, warns that fewer rate cuts might put pressure on lofty earnings expectations over the next several quarters.Companies will need to demonstrate strong outlooks and consistent profit growth to justify these elevated valuations. The path ahead is uncertain, but the decisions made by companies and the actions of the Fed will play a crucial role in determining the future of the stock market.