Earnings beats are now the norm. What the stock market needs to keep rallying

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Will 30% profit growth and upbeat tech guidance be enough to keep the rally going? We'll soon find out.

Third-quarter earnings season kicks into gear Tuesday with JPMorgan Chase and other big banks. Expectations are steep: consensus forecasts call for nearly 30% year-over-year growth, according to FactSet. That's up from around 27% three months ago. But 30% or more should be doable — S&P 500 profits have topped quarterly estimates by healthy margins since mid-2023.

Tech will have to do its part at beating estimates and lifting guidance. For now, the sector shows no signs of slowing. Analysts expect 65% gains for tech profits, up from an estimated 57% growth three months ago. Upward revisions for Nvidia , Micron Technology and Dell Technologies are doing the heavy lifting, according to FactSet.

Also positive, profit growth is broadening beyond the Mag 7. The other 493 stocks in the S&P 500 are forecast to deliver 27% year-over-year gains, topping the Mag-7 average, according to Russell Investments. S&P 400 MidCap operating earnings should rise 19% in 2026, notes Ed Yardeni, head of Yardeni Research.

Banks first at bat

The first earnings test comes with the big banks. JPMorgan, Goldman Sachs , Citigroup , and Wells Fargo , reporting Tuesday, should reveal how steeper interest rates are impacting loan growth, balance sheets, M&A activity and the IPO pipeline. JPMorgan — the largest U.S. bank — will be critical, along with comments from CEO Jamie Dimon who tends to move markets with his outlook.

Financials are on a knife's edge; the sector is hovering around its 200-day moving average, a key technical indicator, after falling 5% since August 31. Analysts see rising interest rates starting to sting loan growth and fixed-income securities held on balance sheets.

The weakness could make for a relief rally, but earnings and guidance could go either way, pushing the stocks up or down, notes Julian Emanuel, senior managing director at Evercore ISI. "There will be volatility as investors hang on every word from the Big Banks this week," he said in a note.

Emanuel remains bullish on the market, however, and tech in particular. Several other strategists concur.

Goldman Sachs shifted to an "overweight" stance on equities Monday, saying "growth remains supportive." The bank's strategists see a favorable macro climate with low recession risk. And they expect inflation to ease in 2027 — all of which points to "more of a 'Goldilocks' backdrop," according to a note by Christian Mueller-Glissmann, head of asset allocation at Goldman Sachs Research.

For positioning, he recommends a "barbell of AI beneficiaries and selective rate-sensitive, high-dividend and low-volatility stocks that could benefit from eventual rate relief."

The setup also looks favorable because multiples have fallen, notes Lisa Shalett, chief investment officer for Morgan Stanley Wealth Management. Stocks are trading at 19 times forward earnings, down from 21 times over the summer, despite the fact that earnings growth has picked up. While rising bond yields have compressed multiples, "that's typical of a midcycle expansion when rate hikes have yet to truly bite," she points out.

Shalett also takes solace in the market's growth drivers. "While many sectors will likely eventually be impacted by higher-for-longer rates, the key growth vectors for this boom — AI capex and wealth-linked consumption — have thus far proved rate-insensitive," she said in a note Monday.

UBS sees gains for equities too. "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 recent note.

More critical than bank earnings may be tech — a sector accounting for 40% of the S&P 500 and about a third of its estimated $800 billion in profits this quarter. Analysts will be looking for signals that AI chip and infrastructure demand are powering through a tough macro climate and higher energy prices, and the stocks will move on 2027 guidance.

The first clues may come when Taiwan Semiconductor Manufacturing Company reports Thursday. Third-quarter profit estimates for TSM are up to $4.45 a share, from $3.42 in January, according to FactSet consensus forecasts. TSM has beaten forecasts in 19 of the last 20 quarters, including a 10.8% beat in the second quarter. Its outlook on chip demand will be a key indicator for Nvidia and other chipmakers.

The Nasdaq 100 is sitting near record highs, however, thanks to a swath of AI companies issuing upbeat reports and new products — easing some of the consternation about the cycle topping out. Micron delivered a knockout quarter. On the consumer side, Meta Platforms' launch of its Muse agent has set off an arms race to capture AI-enabled consumer e-commerce, while also catapulting its stock.

Trouble below the surface?

Granted, the market's reliance on tech belies weakness elsewhere. Of the 504 stocks in the S&P 500, nearly 38% are off 20% or more from their 52-week high. It's a mark of narrow breadth as investors reward a few hot sectors (primarily tech and energy) while others languish.

Earnings revisions have also turned negative in many cases. Eight sectors 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.

Also of note, earnings will be a test for the market's multiple. While the S&P 500's 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.

BofA does see a positive setup for the quarter, expecting 32% earnings growth, a roughly 3% beat to consensus. But after two quarters of companies blowing past forecasts, "healthy beats are the status quo and may not be enough to drive stocks higher," BofA says.

It may also take more than a healthy AI outlook to keep the rally going. As BofA notes, "the interplay between geopolitics, rates and Tech may be underestimated — a higher cost of capital and geopolitical bottlenecks could gum up what has so far been a mostly smooth story."

Something to chew on as markets start digesting third-quarter results.