With the recent US earnings season coming to a close, the outlook for corporate profits looks solid. Investors, however, don’t seem fully convinced and are staying cautious for now.
Large companies broadly beat expectations, helped by resilient profit margins and continued spending on AI-related projects.
On the other hand, there’s been volatility among the AI-linked technology names as investors worry about elevated valuations, mixed forward guidance, and uncertain macroeconomic data out of the US.
This has resulted in markets remaining higher on a year-to-date basis, but narrower and more sensitive to news stories.
What happened during earnings season?
Throughout the S&P 500, earnings season has delivered an unusually high level of companies beating expectations, with a large proportion of companies reporting profits ahead of consensus estimates.
Approximately four-in-five S&P 500 companies beat expectations, a level not seen since 2021. This was concentrated among technology and financial stocks, where AI investment supported the results.
At the same time, year-on-year profit growth has slowed compared to previous quarters; while growth remained positive, it was more conservative than analysts’ expectations.
How has the stock market reacted?
Despite the strong earnings across most sectors, stock markets remained volatile for the season. The S&P 500 returned 4.41% and the tech-focused Nasdaq returned 5.47% for the period.
The technology sector, which has driven much of the market gains, has been the primary area of pullback. Investors seem to be re-pricing stretched multiples, as worries rise around the pace of how much money can actually be made through AI and the sustainability of near-term growth.
Unexpected layoffs and notably weaker labour readings for some companies also added caution for investors, even as broader corporate earnings remain healthy.
How do investment returns actually work?
What’s driving earnings expectations
Moves on earnings days have been a reminder to investors that company-level details still matter, despite the broader picture.
A common theme this earnings season is AI-related company spending.
Large companies continue to capitalise on demand for AI software and services; this has supported revenues, and investors hope for long-term growth going forward.
However, this enthusiasm has continued to funnel investors into the big tech giants.
This creates a dynamic where a small number of firms now account for a large percentage of the index, meaning those companies must keep delivering in order to sustain the market. This is the case with Apple and Google, for example, where AI spending must support future earnings potential.
Looking at the bigger picture
The prolonged US government shutdown has added some noise to the macroeconomic backdrop, and the delay in many official data releases has made investors more reliable on private-sector indicators.
Mixed labour statistics have added ambiguity about what’s next for US interest rates and how quickly the Federal Reserve will cut again.
Both factors are important when it comes to corporate guidance and stock valuations.
Earnings are currently strong enough to support these higher prices, but the wider uncertainty around the economy is elevating the risks for investors.
Is the US stock market in a bubble?
Valuation metrics for the S&P 500 have moved to historically high levels on a forward price-to-earnings basis (how much investors are willing to pay for each dollar of a company’s projected future earnings) principally driven by rising US tech giants.
That concentration, combined with investors’ positioning on the AI trend, has led to many comments warning of a bubble in highly volatile stocks that make up a large part of the S&P 500.
The question remains for investors whether the expected earnings growth will carry to support these higher valuations.
What it all means for investors
For this financial season, US earnings have shown fundamental resilience, but heightened fragility.
The earning beat is real and supportive of a positive medium-term view on how profitable US companies will be ; however, the market’s sensitivity to macro surprises, and the AI narrative, could add some ups and downs in the short term.
Important information
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This content is for information only and is not financial advice. If in doubt you may wish to consult a professional adviser for guidance.