Who needs Disneyland when you can ride the Wall Street roller-coaster for free? Since the beginning of the decade, the ageless Dow Jones Industrial Average (^DJI 0.40%), benchmark S&P 500 (^GSPC 1.02%), and growth-oriented Nasdaq Composite (^IXIC 2.02%), have endured two bear markets (the 2020 COVID-19 crash and 2022 bear market), as well as two periods of exceptionally strong buying activity (2021 and the first eight months and change of 2023).

The big question on investors' minds is whether the rally we've witnessed in 2023 is for real or just another bubble brewing on Wall Street. While there isn't an economic datapoint or metric that can give us a concrete answer, a deep dive into recent earnings revisions offers a big-time clue as to what's happening on Wall Street, as well as what might happen next for stocks.

A bull figurine placed in front of three volatile stock charts, which are set atop a financial newspaper.

Image source: Getty Images.

This is a potentially ominous sign for the stock market

While there's no doubt that investor sentiment and short-term news events can play a role in pushing the Dow, S&P 500, and Nasdaq Composite higher or lower, sustained directional moves in the stock market are, ultimately, driven by corporate earnings. If sales are rising and profits are growing throughout most sectors and industries, we'd expect stocks to move higher. Meanwhile, if corporate sales are declining and earnings are stagnant or falling, a decline in stocks would be the expectation.

However, things aren't always this cut-and-dried on Wall Street.

Last week, Cameron Dawson, the chief investment officer at NewEdge Wealth, shared a number of charts on X, the social media platform formerly known as Twitter, which show earnings estimate projection changes in the S&P 500 and Nasdaq 100 -- an index of the 100-largest nonfinancial companies listed on the Nasdaq stock exchange.  The Nasdaq 100 is of particular interest given that megacap tech stocks have predominantly led the rally in 2023.

As you can see from Dawson's post, estimated earnings per share (EPS) for the Nasdaq 100 have begun to push higher since May for 2023, 2024, and 2025 (data is as of Sept. 8, 2023). In theory, higher EPS could foster additional upside for the current rally. Sounds great, right?

However, a deeper dive into what's pushing these earnings estimates higher is what's concerning.

Although EPS estimates for the market cap-weighted Nasdaq 100 have moved higher by between 8% and 10% for 2023, 2024, and 2025, since the start of July, EPS estimates for the equal-weighted Nasdaq 100 are slightly down or close to the flatline over the same span.

In other words, the increase in estimated EPS for 2023 through 2025 is almost exclusively coming from the narrow group of megacap tech stocks that have outperformed this year. You might know them best as the "magnificent seven."

But even among the magnificent seven, Dawson found sizable EPS revision differences. While Nvidia, Amazon, and Meta Platforms, have had their forward-year earnings (i.e., 2024) revised upward by 40%, 30%, and 11.5%, respectively, since July 1, 2023, Microsoft and Tesla have had their EPS estimates move fractionally lower. The final two members of the magnificent seven, Apple and Alphabet, have had their 2024 EPS estimates creep higher by 1.3% and 2.9%, respectively.

Nvidia, Amazon, and Meta Platforms, are responsible for driving an outsized percentage of upward earnings revisions. Wall Street appears to be increasingly reliant on a narrowing group of companies, which has historically not been a recipe for success.

To boot, megacap tech gains in 2023 have largely come on the heels of investor excitement surrounding artificial intelligence (AI). The problem is every next-big-thing trend on Wall Street for the past 30 years has endured a bubble in its early stages. AI is unlikely to change that trend. This makes Nvidia's trillion-dollar market cap particularly precarious.

A smiling person looking out a window in their home while holding a financial newspaper.

Image source: Getty Images.

Wall Street is a simple numbers game that strongly favors patient optimists

Just as poor market breadth appeared to be a warning sign from earlier this year, poor breadth in earnings revisions is cause for concern in the coming months and quarters. But if your investment horizon extends more than one or two years out, history shows you've got little to worry about.

For instance, the benchmark S&P 500 has averaged a double-digit percentage correction every 1.89 years since the start of 1950. This means downturns in the stock market are probably a lot more common than you realize. Yet, with the exception of the 2022 bear market, every correction, crash, and bear market since the inception of the Dow Jones, S&P 500, and Nasdaq Composite has eventually been cleared away by a bull market.

The major stock indexes moving higher over long periods isn't a surprise. The U.S. and global economy naturally expand over time, which provides an upward lift on corporate earnings -- and earnings growth is what ultimately drives equity prices higher.

Being an optimist tends to pay off handsomely on Wall Street, too. While this isn't to say that short-sellers can't generate hearty profits, being an optimist puts the numbers game entirely in your favor.

Based on calculations from wealth management company Bespoke Investment Group, the average bull market for the S&P 500 since September 1929 has lasted 1,011 calendar days. That compares to the typical bear market for the S&P 500, which has lasted 286 calendar days over the same timeline. 

While recent earnings revisions may portend trouble for the broader market in the coming quarters, patience and optimism have demonstrated, time and again, why they're a winning combination on Wall Street.