“Up, up and away
(in) My beautiful
My beautiful balloon
Up, up and away
Up, up and away…”
– (From “Up, Up and Away,” performed by the 5th Dimension, 1967)
By Scott Welch, CIMA®, CEPA®, Chief Investment Officer & Partner
Reviewed by Carter Mecham, CMA®, IACCP®
It is almost impossible to read or listen to any financial media today without reading or hearing a discussion about earnings.
Earnings have always been important, of course, so why the particular focus now?
One important reason is that earnings have been so strong recently and are expected to remain strong well into future quarters.
Another is that the current valuations of many companies, especially the mega-cap tech stocks and so-called “hyperscalers” are dependent on those firms maintaining and improving already robust earnings profiles.
A third potential reason is that investors have enjoyed a strong stock market (with some volatility) since 2023 (first chart), but the drivers of that performance have changed.
In 2023 and 2024, US market performance (as measured by the S&P 500 index) was driven largely or significantly by an expansion of the P/E multiple – that is, investors willing to pay an increasing amount for a dollar of earnings.
But in 2025, performance was driven almost exclusively by earnings growth. And in Q1 2026, P/E multiples actually contracted, so the index posted a negative result despite solid earnings (second chart).
Source: Ycharts, data from January 2, 2023 through July 28, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Sources, First Trust, FactSet, data through Q1 2026. You cannot invest in an index, and past performance is no guarantee of future results.
This P/E contraction may explain why the performance of the S&P 500 index has not kept up with robust earnings growth estimates.
Source: FactSet and Goldman Sachs, as of May 27, 2026. These are estimates and subject to change. You cannot invest in an index, and past performance is no guarantee of future results.
Another way of examining the increasing dominance of earnings on stock prices is by looking at the so-called “PEG” ratio, which is calculated by dividing the P/E ratio of a stock by its expected earnings growth rate.
A declining PEG ratio suggests that the denominator – the expected earnings growth rate – is growing faster than the numerator P/E ratio. That is, valuation is being driven increasingly by earnings growth.
Source: The Daily Shot, as of July 27, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
This is not simply a US phenomenon – most major geographic markets have recently been earnings versus multiple expansion-driven.
Source: JP Morgan “Guide to the Markets,” as of July 27, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Now, we happen to believe that a market rally driven by strong earnings is healthier than a rally driven by multiple expansion – but that rally only lasts as long as earnings continue to grow at or above investor expectations.
And the higher earnings go, the harder it becomes to keep doing better.
One distinct positive aspect of this trend is that the earnings-led market rally has brought global valuations back down much closer to historical averages.
Source: Eaton Vance “BEAT Report,” as of June 30, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
So, where do we go from here? Let’s dive in.
A Look at the Current Earnings Environment
As we write this, we are a little more than halfway through the Q2 earnings season and, so far, the results have been positive. Both the revenue and earnings “beat rates” (performance coming in better than forecasted) are at multi-year highs, with more than 80% of companies reporting positive revenue surprises and more than 85% reporting positive earnings surprises.
Source: Zacks Earnings Report, as of July 29, 2026. Solid bars are actual results while hashed bars are estimates and subject to change. You cannot invest in an index, and past performance is no guarantee of future results.
We have commented in previous blogs on the expectation that earnings will continue to grow (green bars) while revenues are expected to remain relatively flat (orange bars).
We can only attribute this to an expectation that Artificial Intelligence (AI) and Robotics will drive significant increases in productivity across the market.
We believe that is a reasonable expectation over time, but investors may react negatively if it doesn’t happen as quickly as they seem to be pricing into current market levels.
There has been much media attention given to the current “malaise” in the performance of the mega-cap tech stocks – as a collective group they are negative or slightly positive on the year (despite Microsoft’s record-breaking jump after it reported its earnings) and are underperforming both the overall S&P 500, the equal-weight S&P 500, and the small cap S&P 600 indexes – we certainly have not seen that phenomenon in several years.
Source: Ycharts, YTD data through July 30, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
How do we “square the circle” of these stocks performing so poorly this year despite dominating the overall index earnings picture?
We believe there are several possible reasons, but two of them might be:
- Investor Fatigue. After several years of relative euphoria over Artificial Intelligence, hyperscalers, and semi-conductors, investors may simply think this remarkable rally has run its course and are seeking to take gains and reallocate to other parts of the market (e.g., small cap stocks have outperformed significantly YTD and value stocks have outperformed growth stocks over the past three months).
- The mega-cap tech stocks have committed to raising billions of dollars for Capital Expenditures (CapEx), specifically the build out of data centers to meet the parabolic increase in demand for computing power. They are funding this in two ways – by raising massive amounts of debt and by burning through free cash flow. Low levels of debt and massive free cash flow have historically been two of the most positive characteristics of these companies. Investors increasingly wonder if/when these massive capital outlays will turn into profits.
We can see this cash flow phenomenon across the entire spectrum of the hyperscalers.
Source: John Authers and Bloomberg Daily, as of July 28, 2026.
Source for the previous two charts: Torsten Slok, Apollo, as of July 29, 2026. These are estimates and subject to change.
What are the Expectations for Future Earnings?
Given the importance of future earnings on maintaining current market momentum and pricing levels, what are expectations for those earnings?
For the S&P 500 we can see that the growth estimates for 2026 continue to climb as we move through each quarter.
Source: Yardeni Research, as of July 23, 2026. These are estimates and subject to change. You cannot invest in an index, and past performance is no guarantee of future results.
Furthermore, the consensus forecast is for steady earnings growth through 2027.
Source: FEG “Portfolio Insights,” as of June 30, 2026. These are estimates and subject to change, You cannot invest in an index, and past performance is no guarantee of future results.
We can see that expectations for non-US earnings growth are robust as well.
Source: JP Morgan “Guide to the Markets,” as of July 27, 2026. These are estimates and subject to change, You cannot invest in an index, and past performance is no guarantee of future results.
Interestingly, we saw a steady growth in US earnings estimates as we moved through the second quarter. This is somewhat of an historical anomaly – earnings estimates tend to move down as a quarter progresses. To some degree companies prefer this downward trend, as it makes it easier to beat expectations.
Source: State Street Global Advisors “ETF Chart Pack,” The left chart is through June 30, 2026. The right chart is sourced from the IMF World Economic Outlook as of April 30, 2026. These are estimates and subject to change. You cannot invest in an index, and past performance is no guarantee of future results.
Focusing more narrowly, one possible reason for the excellent relative performance of US small caps this year is the expectation that small caps are expected to show higher earnings per share growth than US large or mid-caps.
Source: Yardeni Research, as of July 23, 2026. These are estimates and subject to change, You cannot invest in an index, and past performance is no guarantee of future results.
Although value has performed well this year, the current consensus is that earnings in growth stocks will solidly beat those of value stocks as we move through the year.
As a result, the relative price performance of these two risk factors going forward will, to some degree, depend on starting valuations of each and changes in interest rates (growth stocks are more inversely correlated than value stocks to changes in interest rates).
Source: Yardeni Research, as of July 16, 2026. These are estimates and subject to change, You cannot invest in an index, and past performance is no guarantee of future results.
Interestingly enough, despite their earnings prowess, the mega-cap tech stocks are expected to post earnings growth below that of the broader S&P 500 market.
We suspect this is a function of how much higher their earnings already are (as we mentioned, the higher you go, the harder it gets to keep increasing at the same rate).
This may also partially explain the relative underperformance of these stocks YTD.
Source: Yardeni Research, as of July 16-24, 2026. These are estimates and subject to change, You cannot invest in an index, and past performance is no guarantee of future results.
As the mega-cap tech stocks report their Q2 earnings, we see an interesting phenomenon. Investors are clearly beginning to separate perceived winners and losers in the massive CapEx spending spree.
Those firms that seem to be closer to realizing higher profits from their AI spend are being rewarded while those who seem farther away are being punished for their decline in free cash flow, even if they posted positive results for the quarter.
Take a look at the performance of the mega-cap tech stocks over the past two weeks (as we write this) and notice the divergence of performance following earnings announcements. Tesla missed its “numbers” and was punished accordingly, and Microsoft enjoyed the largest price increase in its history.
However, despite posting solid revenue and earnings numbers, Apple, Alphabet (Google), and META (Facebook) were punished for concerns over their decline in free cash flow. Nvidia does not report until late August.
Source: Ycharts, data from July 20 – July 31, 2026. Past performance is no guarantee of future results.
That being said, we see a different story if we move away from the hyperscalers and focus on the provider of the goods and services to those firms (e.g., chips and semi-conductors) – that is, the sellers of “picks and shovels” versus the “miners” themselves.
Source: FactSet and Goldman Sachs, as of May 27, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Summary and Interpretation
It is worth the time to examine earnings, multiples, and valuations because of a fundamental principle of investing: What you can earn on any given investment is significantly impacted by how much you pay for it today.
Today’s markets are not cheap, although the earnings growth phenomenon has brought valuations down to more historically normal levels.
Still, based on the overall current P/E of the S&P 500 index of approximately 19.6x, investors should probably not expect the same level of robust returns we have enjoyed for the past 2-3 years.
Source: JP Morgan “Guide to the Markets,” as of July 27, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
It is fair to say that we currently are enjoying an “earnings boom”, and this has kept the market afloat despite the Iranian War and corresponding volatility in oil prices, as well as a new Fed Chair, Kevin Warsh, who is deliberately trying to cut back on “signaling the market” regarding Fed rate decisions, which has re-introduced volatility back into the bond market. [It has been years since we’ve seen the phrase “bond vigilantes” used as frequently as now.]
At the overall economic level, the capital expenditure rates of the hyperscalers is adding growth to the overall GDP levels. Growth is growth, but it is a fair question to ask how long that can last. Especially if investors turn sour on all that spending because they are not seeing the appropriate trade-off in profitability by those firms.
Earnings are always important – they are the lifeblood of the capital markets. But we get the sense that the next 3-4 quarters of earnings reports will be especially important in determining where the equity markets go from here.
As always, we welcome your questions and feedback.