US Q3 Earnings Season Kicks Off: Profit Growth Expectations Approach 30%Can They Push the S&P 500 to New Highs?

US Q3 Earnings Season Kicks Off This Week. As earnings roll in, a scene the market has been eagerly awaiting may come true: another explosive surge in S&P 500 profits. On Tuesday, US stocks closed at record highs, with investors betting that AI capital expenditures will not be derailed by rising bond yields. AI capital spending has become an important DRIVE for the US market and economy. If key companies provide optimistic guidance, combined with a stabilizing bond market, it could help US stocks finish the year strongly. AI Engine Running at Full Speed: S&P 500 Earnings Growth Approaching 30% At the index level, profit growth is expected to be very strong. Consensus expectations compiled by FactSet show that analysts expect S&P 500 constituent companies' third-quarter earnings to grow nearly 30% year-over-year, above the 26.7% forecast as of June 30. The technology sector remains key. It accounts for 40% of the S&P 500's weight. If earnings expectations declined, that would normally raise concerns, but the reality is the opposite. FactSet noted that the expected EPS growth rate for the technology sector has risen from 57% on June 30 to the current 65%, partly helped by upward revisions to earnings expectations for NVIDIA Corporation(NVDA.US) and Micron Technology, Inc.(MU.US). Analysts Raise Earnings Growth Forecasts Strong results from AI chipmakers and other large technology companies have eased market concerns about a cyclical peak. Micron delivered strong financial results, sending a positive signal for broader AI chip demand. On the consumer side, Meta Platforms launched the Muse agent, igniting an arms race in AI-enabled consumer e-commerce. More critically, earnings growth is spreading beyond the "Magnificent Seven." Data from Russell Investments shows that these giants are expected to grow by an average of 20%, while the other 493 stocks in the S&P 500 are expected to grow 27% year-over-year. Beyond large caps, earnings growth for small and mid-cap stocks is also healthy. Ed Yardeni, head of Yardeni Research and economist, noted that operating profits for the S&P 400 MidCap Index are expected to grow 19% in 2026. He added that analysts expect S&P 600 small-cap earnings to grow 21% this year and 16% in 2027. Barclays strategists said in a report this week: "The stock market is still reacting to corporate earnings." They wrote that S&P 500 profits are expected to grow 30% this year, and said: "2025-27 could be the fastest three-year earnings growth period in decades (excluding post-recession rebounds)." UBS Group AG is equally optimistic. Ulrike Hoffmann-Burchardi, CIO for the Americas in the UBS Group AG Chief Investment Office and global head of equities, said in a report on Wednesday: "Investors should continue to position for market upside, and we expect the S&P 500 to rise to 8,400 by June next year." Cracks Beneath the Boom: Deteriorating Market Breadth, Bond Market Pressure Interfering However, stocks outside the "Magnificent Seven" and major chipmakers still need an earnings boost. Market breadth is deteriorating. Morgan Stanley data shows that as of the end of September, only about 20% of stocks were trading above their 50-day moving averages, down from 70% in midsummer. Beyond large caps, a large number of stocks are mired in bear markets. Of the S&P 500's 504 constituents, nearly 38% are down 20% or more from their 52-week highs. Companies down at least 50% include CoStar Group, Inc.(CSGP.US), Applovin(APP.US), Boston Scientific Corporation(BSX.US), Oracle Corporation(ORCL.US), and Coinbase(COIN.US). At the sector level, the outlook is not uniformly bright. Although all S&P 500 sectors are expected to achieve growth, FactSet data shows that since June 30, bottom-up EPS estimates have been revised down for eight sectors, led by materials (-10.2%), consumer staples (-4%), and healthcare (-3.3%). Even if index profits are strong, rising bond yields could disrupt the rally. The 10-year US Treasury yield has just broken through 5.36%, a 24-year high, up from 4.75% in August. Part of the yield increase reflects strong economic growth, but it also reflects persistent inflationary pressure. The core PCE inflation gauge preferred by the Federal Reserve was 3% in August. If the economy does not fall into recession, several more rate hikes may be needed to bring inflation closer to the 2% target. Rising rates put pressure on high-dividend sectors such as utilities, consumer staples, and real estate. Banks may also come under pressure from fixed-income portfolios, accumulating losses on their balance sheets. For now, rising rates have not been enough to weaken the AI trade and other earnings growth drivers. Barclays strategists believe the market may be unaffected even if rates rise by one percentage point. They noted: "If earnings grow 30% and real rates rise 100 basis points, earnings growth (if not yet priced in) still wins. The stock market understands thisthat is why share prices have remained firm and unwilling to fall." Bank Earnings and the Valuation Test: US Stocks Need to Clear "Three Hurdles" for a Year-End Rally Investors should pay close attention to earnings reports from major banks next week to understand how higher rates are affecting lending, M&A activity, and IPO plans. JPMorgan, Goldman Sachs Group, Inc., Citigroup, and Wells Fargo & Company will report earnings on October 13. Earnings will also test the market's lofty valuations. Although the S&P 500 forward P/E has fallen to about 19 times, Bank of America Corp said that 17 of 20 valuation metrics show the index is "expensive," implying an annualized return of -3% over the next decade. On short-term positioning, Bank of America Corp said its momentum and value models favor energy, technology, and communication services. Jefferies Financial Group Inc. favors sectors with improving earnings and "macro support," noting that financials, healthcare, technology, and materials will benefit. For US stocks to continue strengthening through year-end, multiple conditions need to be met simultaneously: results from large technology companies, banks, and other key companies must beat Wall Street expectations; bond yields need to stabilize; oil prices need to fall, preferably well below $100 per barrel with support from an Iran peace agreement. If all these conditions are met, US stocks could be poised for a strong finish to the year.