Here comes third-quarter earnings season. Booming profits could propel the S&P 500 to new heights

Third-quarter earnings season kicks off this week and as results roll in they should reveal what the market is eagerly anticipating: another blockbuster quarter for S&P 500 profits. The market closed at record highs Tuesday as investors bet that AI capex — a major force for the markets and economy — won't be derailed by higher bond yields. Assuming upbeat guidance from key companies — along with a little help on the bond side — earnings could propel stocks to a strong finish for the year. At the index level, profit growth should be stellar. Analysts expect nearly 30% year-over-year earnings growth for the S&P 500, according to consensus estimates compiled by FactSet. That forecast is up from 26.7% on June 30th. Tech, of course, is the critical sector, accounting for 40% of the S&P 500. That would be a worry if profit estimates were falling, but they're going in the opposite direction. Estimated EPS growth for the tech sector has increased to 65% today from 57% on June 30, thanks partly to upward revisions for Nvidia and Micron Technology, FactSet notes. Indeed, strong results from AI chipmakers and other big tech names have eased some of the consternation about the cycle topping out. Micron delivered a knockout quarter, a positive sign for broader AI chip demand. On the consumer side, Meta Platforms' launch of its Muse agent has set off an arms race to capture AI-enabled consumer e-commerce. Critically, earnings growth is broadening beyond the Mag-7. While those companies are expected to notch an average 20% growth, the other 493 stocks in the S&P 500 are forecast to deliver 27% year-over-year gains, according to Russell Investments. Profit growth also looks healthy below the large-cap surface. S&P 400 MidCap operating earnings should rise 19% in 2026, notes economist Ed Yardeni, head of Yardeni Research. Analysts expect S&P 600 SmallCap earnings to increase 21% this year and 16% in 2027, he adds. "Equities are still responding to earnings," Barclays strategists said in a note this week. S&P 500 profits are on track to rise 30% this year, they write, adding: "2025-27 is set to be the fastest three year period of earnings growth (absent a recession rebound) in many decades." UBS also struck a bullish tone. "Investors should remain positioned for market upside, and we forecast the S&P 500 to reach 8,400 by June next year," said Ulrike Hoffmann-Burchardi, CIO Americas and Global Head of Equities for UBS Chief Investment Office in a note on Wednesday. Trouble below the surface? Granted, stocks beyond those in the Magnificent Seven and major chipmakers could use an earnings lift. The market has a deteriorating breadth problem. Only about 20% of stocks were trading above their 50-day moving average at the end of September, down from 70% in midsummer, according to Morgan Stanley. Beneath the megacap surface, legions of stocks are languishing in their own bear markets. Of the 504 stocks in the S&P 500, nearly 38% are off 20% or more from their 52-week high. Companies down at least 50% include CoStar Group, AppLovin, Boston Scientific, Oracle, and Coinbase Global. It's not all roses at the sector level. While every S&P 500 sector is expected to post growth, eight have seen negative revisions in bottom-up EPS estimates since June 30, led by materials (-10.2%), consumer staples (-4%) and health care (-3.3%), according to FactSet. Even if profits come in strong for the index, rising bond yields could spoil the party. The 10-year Treasury yield just hit a 24-year high above 5.36%, up from 4.75% in August. Some of the increase reflects strong economic growth, but it's also baking in inflationary pressures that won't quit. Core PCE inflation, the Fed's preferred gauge, was 3% in August. A few more rate hikes may be needed to bring inflation closer to the Fed's 2% target, assuming the economy doesn't dip into a recession. Rising interest rates pressure high-yield sectors like utilities, consumer staples and real estate. Banks could also feel the pinch on their fixed income portfolios, racking up losses on balance sheets. For now, the rise in rates hasn't been enough to dent the AI trade and other forces fueling earnings growth. Barclays strategists argue the market could even shrug off a one percentage point rise in rates. "If earnings are growing at 30% and real rates rise 100bp, the earnings growth (if not priced in) still has the upper hand," they note. "The equity market understands this — which is why stocks stubbornly refuse to fall." Investors should keep a close eye on the big banks reporting next week, offering insights into how higher rates are impacting lending, M&A activity and the IPO pipeline. JPMorgan Chase Goldman Sachs, Citigroup, and Wells Fargo report October 13. Also of note, earnings will be a test for the market's pricey multiple. While the S&P 500's forward P/E has dropped to about 19 times, the index "reads expensive" on 17 of 20 valuation measures, according to Bank of America, adding that implies a -3% annualized return over the next decade. As for positioning near-term, BofA says its momentum and value models favor energy, tech and communication services. Jefferies favors sectors with improving earnings and "macro support," highlighting financials, health care, tech, and materials as beneficiaries. Several things will have to go right for stocks to power ahead through year end. The major tech companies, banks, and other key firms will need to beat Wall Street's estimates; bond yields need to stabilize; and oil needs to come down, ideally trading well below $100 a barrel, backed by a peace deal with Iran. Assuming it all comes together, stocks should deliver a strong finish to the year.