Wall Street analysts are showing record optimism regarding the earnings growth of S&P 500 companies. Over the past six months, consensus forecasts have been revised upward by nearly 20% — the fastest pace since 2021. However, experts warn that such expectations may not materialize, forming an "earnings bubble."
Current forecasts suggest a 25% increase in S&P 500 company earnings over the next year. The main drivers of this optimism are chipmakers and server manufacturers, whose stocks are at the center of the artificial intelligence boom. However, according to a number of analysts, reality may turn out differently.
"Earnings Bubble": Risks and Warnings
Ben Inker, co-head of asset allocation at GMO, notes that forecasts for the next two years are growing "unusually quickly" — something not seen outside of post-crisis recovery phases. He warns that markets will eventually see that these expectations will not be met. Michelle Lerner, who heads the HOLT analytical platform at UBS, speaks of the formation of an "earnings bubble." According to him, AI-related stocks are already pricing in the persistence of super-profits, but the likelihood of maintaining such a level of profitability is extremely low.
The S&P 500 index has risen 20% over the year, and the Nasdaq Composite has gained more than 25%, posting its best quarter in six years. The rise in earnings forecasts supports stock valuations, even as indices hit new highs. Currently, stocks are trading at nearly 20 times projected earnings, which is noticeably lower than during the peak of the dot-com bubble and last year's rally. However, this multiple remains vulnerable.
Additional Pressure: Interest Rates
Investors also point to another risk: traders are pricing in at least one 0.25 percentage point rate hike by the end of the year. Such a reversal signals a departure from previous expectations of rate cuts, creating additional pressure on earnings multiples, which already seem inflated.
Kasper Elmgreen, chief investment officer for fixed income and equities at Nordea Asset Management, notes that the market has almost no room for error. According to his assessment, companies are approaching the second quarter with minimal margin of safety, and he questions whether they can continue to delight investors with above-expectation results.
My view: The market is clearly overheated with expectations, and any disappointment in reports could trigger a correction. Investors should be cautious, especially in the AI sector, where valuations are already detached from fundamental indicators.