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Earnings Surge: Market's Perilous High?
14 Jul
Summary
- S&P 500 earnings growth is 24% higher than a year ago.
- Forward P/E multiple has compressed from 22 to 20.7.
- Profit margins and share of GDP are already at record highs.
The stock market faces a peculiar challenge as corporate earnings, up 24% year-over-year, potentially outpace sustainable growth. While consensus forecasts for S&P 500 earnings have escalated, the index has flattened, compressing its forward price-to-earnings multiple from nearly 22 to 20.7. This impressive growth, largely fueled by AI-capex beneficiaries, is reportedly broadening across sectors.
Veteran strategist Jim Paulsen notes S&P 500 EPS is over 60% above its historic trendline, the highest in the post-war era. Despite historically high valuations, a declining P/E multiple alongside rising prices might signal future disappointment, as investors may resist extrapolating such gains indefinitely.
The sustainability of record-high profit margins and profit share of U.S. GDP is questioned, especially as these levels are more typical of post-recession recoveries. Concerns arise that companies might be "over-earning" or front-loading benefits of an investment boom.
Four "hyperscalers" now represent 16% of the S&P 500, sacrificing free cash flow for computing capacity, while semiconductor makers, at an 18% weighting, benefit from soaring prices. This dynamic is tempering the overall index multiple, with hyperscaler valuations declining toward or below the S&P 500 average.
Bank of America strategist Savita Subramanian sees no signs of earnings momentum rolling over, citing strong estimates and positive survey data. However, she also alerts to potential erosion in earnings quality, noting contributions from marked-up private AI stakes. The recent sideways churn in the S&P 500 and cooling tech performance could be the market's prelude to upcoming results.
