- Analysts expect a third straight quarter of 25%-plus profits growth from the S&P 500 index
- Earnings forecasts continue to rise, led by energy, technology and materials companies
- The AI spending boom is a key driver, alongside the ripple effects of the war in the Middle East and rampant US government spending
- Strong profits momentum is helping stock markets brush off worries over tariffs, input cost inflation, rising bond yields and lofty valuations
- Bond yields could yet have a say, especially if profits disappoint for any reason
“Legendary stock market plunger Jesse Livermore once argued, “There is only one side of the market and it is not the bull side or the bear side but the right side,” and, right now, it is equity bulls who are on the right side of the trade as the S&P 500 barrels to new all-time highs,” says AJ Bell Investment Director Russ Mould.
“This sets the scene for the third-quarter earnings season, which starts on Friday with Delta Air Lines and then moves up a gear when the American megabanks JP Morgan Chase, Goldman Sachs, Citigroup and Wells Fargo report. Further rapid profits growth is expected, with energy, technology and mining leading the charge, but in some ways those lofty increases are needed to justify what are, in some cases, historically high valuations.
Source: LSEG Refinitiv data
“After a bumper first half to 2026, and strong guidance for the July-to-September period, the outlook for US corporate profits does seem bright, and this matters to financial markets the world over, given the old adage that where America goes the rest tend to follow.
“Consensus analysts’ forecasts suggest that the S&P 500’s members will generate year-on-year earnings growth of 29.5% in the third quarter, and that would make it the third period in a row of growth of at least 25%, according to FactSet.
“Thanks to technology stocks in particular, but with energy and industrials chipping in, analysts now believe that the S&P 500 index’s constituents will generate record earnings in 2026 and 2027.
“Analysts also continue to upgrade their forecasts. At the start of this year, consensus estimates were looking for 17% growth in S&P 500 aggregate earnings to $310 a share. Now analysts expect a 32% rate of increase to $346, with a further 16% advance in 2027 to $400.
“Both figures are miles ahead of the last twenty years’ compound annual growth rate of 6.4.%.
Source: Company accounts, S&P Global, FactSet
“Such momentum underpins the bull case, and both the bulk of the earnings growth and the profit forecast upgrades, stem from technology and the Artificial Intelligence spending boom in particular.
“Higher oil and metal prices, and bulging refining margins, are helping the Energy and Materials sectors, thanks in part to the war in the Middle East and the US government’s substantial annual budget deficit is aiding many other sectors, notably defence and industrials. In addition, AI is driving profits across not just the Information Technology sector, but Communications Services (the home of Alphabet and Meta Platforms) and even Consumer Discretionary (which contains Amazon).
Source: Company accounts, FactSet, consensus analysts' forecasts
“Some of these profits are capital gains booked on holdings in other AI firms, such as SpaceX or OpenAI, and thus paper, not cash. This is not the highest quality form of earnings either, as they could be easily reversed if the AI boom starts to run out of puff, but bulls do not seem to mind. Nor do the AI hyperscalers show any sign of cutting their spending budgets, despite a brief call from Anthropic’s Dario Amodei and Open AI’s Sam Altman for a pause in the pace of development.
“That investment is rippling through the AI food chain, from construction equipment firms to data centre operators, to providers of power and water for those facilities, to servers and compute providers, to silicon chip and memory specialists and all the way through to the semiconductor production equipment (SPE) suppliers.
“Any whiff of a slowdown in spending could be the first tremor so far as earnings are concerned, so the hyperscalers’ cash flow statements and capital expenditure figures, both historic and forecast, could be just as important as their actual earnings numbers.
Source: Company accounts, Marketscreener, analysts’ consensus forecasts
“Until then, however, share prices and equity valuations seem determined to sweep aside the dangers posed by tariffs, the war in the Middle East, and soaring sovereign bond yields.
“The last-named could be the biggest danger of all, particularly if corporate earnings disappoint for any reason.
“Consensus earnings forecasts put the US stock market on 22.6 times earnings for 2026, and 19.5 times for 2027. Put another way, the earnings yield on the S&P 500 is 4.4% for this year, as that figure is simply the inverse of the price/earnings ratio.
“But the yield on a US ten-year Treasury bond is now 5.3%, so bonds offer a premium return and – in theory – a safer one at that, at least in nominal terms, since the US government has never defaulted and corporate profit forecasts can sometimes prove over optimistic.
Source: LSEG Refinitiv data
“From an equities point of view, that is far from ideal, as it suggests stocks are getting expensive, since investors are no longer farming the equity risk premium and getting lower returns relative to purportedly less risky bonds.
“The earnings yield was also below the Treasury yield by the time the tech, media and telecoms (TMT) bubble popped, weighed down by the combination of lofty earnings expectations that were not met and left equally lofty valuations exposed on the downside.
“However, the premium offered by ten-year Treasury relative to the earnings yield was a full three percentage points, not the near-one point premium offered today. There are a lot of moving parts here, but either Treasury yields have to keep motoring, earnings forecasts have to plunge, or the S&P 500 has to rocket for that gap to open up again. Things could, in theory, get even frothier still, if the last-named scenario comes to pass and bull markets do tend to end with a final, meteoric surge.
“Equally, it could be that earnings do disappoint, if AI does not deliver the expected productivity gains as quickly as everyone hopes and the hyperscalers decide to cut capex, or are forced to do so by shrunken cash flows or higher borrowing costs as investors rebel against complex vendor financing schemes.
“In this respect, we could be in an earnings bubble, not a valuation bubble, as the hyperscalers’ capex fails to generate the returns expected and retrenchment punctures profits right the way across the AI food chain, in what would be a painful reminder of hedge fund manager Seth Klarman’s assertion that, ‘At the root of all financial bubbles is a good idea carried to excess.’”
