With the third quarter behind us, earnings season is back underway, which means investors are once again preparing for that special annual tradition: corporate executives explaining why everything is somehow both fantastic and concerning at the same time.
For now, expectations remain remarkably strong. The S&P 500 is projected to deliver year-over-year earnings growth of 29.5%, marking a third consecutive quarter above 25%. Even more notable, earnings estimates actually rose during the quarter. That's unusual because analysts typically revise forecasts downward throughout a quarter with the steady determination of someone gradually lowering their expectations for a group vacation.
Energy led revisions higher, with estimates increasing 18%, followed by Information Technology at 3.5%.
Management teams appear similarly optimistic. A record 72 companies issued positive earnings-per-share guidance, surpassing the previous high of 65 in 2Q21. Information Technology accounted for 44 of those companies, followed by Industrials with 10.
Semiconductors & Semiconductor Equipment were a major contributor, which isn't exactly shocking given that AI currently occupies about the same amount of market attention as Taylor Swift occupied football game broadcasts last year. More surprising was Software's showing. Twelve software companies issued positive guidance compared with 11 semiconductor companies, reminding investors that while chips may be the stars of the AI story, somebody still has to give those chips something useful to do.
What's particularly interesting is that the two sectors driving earnings revisions, Technology and Energy, have delivered very different signals to the broader market. Over the last year, the S&P 500 gained a cumulative 92% across trading days when Semiconductor stocks rose and lost a cumulative 40% across days when they fell. That roughly 133 percentage-point spread was the largest among all industry groups. At this point, calling Semiconductors "important to the market" feels a bit like saying oxygen is important to breathing.
Energy tells the opposite story. Across the days when Energy stocks rose, the S&P 500 declined a cumulative 5.7%, while it gained 22.4% across days when Energy stocks fell. In other words, Semiconductor rallies have generally coincided with investors feeling optimistic about growth, while Energy leadership has often emerged when investors are worried about inflation, geopolitical tensions, or the economy.
That’s an important distinction because not all positive earnings revisions mean the same thing. Some signal confidence in future growth, while others reflect concerns that could weigh on the broader market.
That brings us to the question hanging over this earnings season: AI. Investors have spent the past two years enthusiastically funding what increasingly resembles the largest corporate spending spree since someone convinced every office it needed a fax machine in every room. The next phase is determining whether all that spending translates into sustainable revenue growth and profits.
Markets have been extraordinarily willing to reward companies for building the future; this earnings season may reveal which companies are actually getting paid for it.
Advisor Angles
AI spending is looking for a paycheck. Clients may hear a lot about AI spending, which has been enormous. Investors now want evidence that companies can turn that spending into revenue, profits, and something more substantial than an extremely confident presentation.
Client talking points
- Not every company tied to AI is likely to benefit to the same degree.
- Investment returns will increasingly depend on execution, not just participation in the AI theme.
- Patience may be required as the market sorts out which companies are generating lasting business value from AI investments.
Expectations have become their own risk. Strong earnings can still disappoint when expectations have climbed too high. Some companies are no longer being asked to clear the bar; they’re expected to pole-vault over it while posting higher guidance on the way down.
Client talking points
- Strong company results do not always translate into immediate stock gains.
- Short-term volatility can occur even when underlying business fundamentals remain healthy.
- Market expectations can be just as important as earnings results when determining stock performance.
Market leadership remains highly concentrated. A small group of market leaders continues to attract an extraordinary amount of attention. Concentration feels harmless while those stocks are rising…much like a roof leak feels harmless when it isn't raining.
Client talking points
- Recent market gains have been driven by a relatively narrow group of companies.
- Diversified portfolios may not always keep pace with the market's most popular stocks.
- Diversification can help reduce the impact if leadership broadens or current market leaders stumble.
Earnings season tests the narrative. Every bull market runs on a story; earnings season is when that story has to show its receipts.
Client talking points
- Earnings reports can help distinguish between investor enthusiasm and business results.
- Management commentary may provide insight into future growth, spending plans, and demand trends.
- Long-term investment outcomes ultimately depend on business performance supporting investor expectations.