Wall Street Earnings Soar While Market Valuations Face Growing Pressures
Bank Hapoalim's Ziv Kramer reviews Wall Street's strong earnings and persistent valuation gaps, driven by surging real yields and shifting market sectors.
Ziv Kramer, head of foreign equities at Bank Hapoalim's trading room, recently published a comprehensive review analyzing the Wall Street earnings season, the surge in corporate profits, and the core factors that will determine market trajectories heading into the final quarter of the year.
Earnings Surprises and Valuation Dynamics
Following another robust earnings season where S&P 500 companies delivered exceptional aggregate performances, market watchers are evaluating Wall Street sentiment amid sluggish equity movements. Notably, the S&P 500 index edged up by merely 0.5% during the third quarter.
Second-quarter earnings reports proved exceptionally strong. Aggregate figures revealed that earnings per share (EPS) exceeded analyst projections by 26.17%. Even after stripping out one-time accounting gains reported by tech giants like GOOGL and Amazon, the overall figure adjusts to 10.8%—still significantly higher than the five-year average of 7%.
Revenue metrics similarly reflected positive momentum, with companies beating analyst forecasts by roughly 3.27%. Furthermore, 76% of firms reported revenues that surpassed expectations, underscoring historically strong operating performances.
The Disconnect Between Profits and Index Returns
Despite impressive profit growth, the sluggish performance of the broader index remains difficult to ignore. Although the S&P 500 has climbed approximately 12% since the beginning of the year, it concluded the third quarter with near-zero returns, highlighting a widening gap between corporate earnings growth and actual index performance.
This divergence is clearly mirrored in market valuations. The forward price-to-earnings (P/E) multiple for the next 12 months dropped from 20.7 on June 1 to roughly 19 by the end of the quarter, falling well below the 23.6 recorded at the close of 2025 and the five-year average of approximately 19.9. According to FactSet, over the same period, 12-month forward EPS forecasts rose by 8.9%, while the index itself gained a modest 2.7%. Consequently, expected earnings expanded at a significantly faster pace than index prices, meaning investors are currently paying less for every dollar of future earnings.
"The expected earnings have risen at a significantly faster pace than the index price, leading investors to pay less today for each dollar of future earnings."
Drivers of Market Friction
Why is the benchmark index struggling within such a favorable business environment? Analysts point to two primary catalysts. First, specific market pockets are vastly outperforming the broader economy. The energy sector benefits from rising commodity prices, while semiconductors and software exhibit a distinct decoupling from the real economy. This indicates that relative weakness within the index does not necessarily reflect widespread corporate underperformance, but rather stark disparities across sectors and constituent stocks.
Second, yield curves are scaling historical highs across various maturities, particularly at the long end, thereby presenting a viable alternative to equity investments. Currently, the yield on the 10-year US Treasury note stands at 5.25%, outpacing the S&P 500 earnings yield of roughly 5.2%. Concurrently, rising discount rates diminish the present value of future corporate cash flows and earnings.
Real Yields Versus Inflation Expectations
While prevailing sentiment attributes climbing yields primarily to inflationary pressures, data suggests a more nuanced reality. During the third quarter, the 10-year Treasury yield climbed by approximately 83 basis points. Over the same timeframe, the yield on Treasury Inflation-Protected Securities (TIPS) rose by 87 basis points, whereas inflation expectations, measured via the breakeven rate, declined by about 3 basis points.
In other words, the core surge in 10-year yields stemmed directly from rising real yields rather than parallel shifts in inflation expectations. This distinction carries profound implications for the equity market, as real yields elevate investment alternatives to stocks and increase the discount rate applied to future earnings.
Wall Street Analyst Outlook and Sector Preferences
Looking ahead to the third-quarter earnings season, Sell-Side analysts maintain an optimistic stance. Among all recommendations, 59.9% are rated as "buy," 35.5% as "hold," and 4.7% as "sell." This proportion of buy ratings exceeds the five-year average of 55.9%.
Should this 59.9% ratio hold steady, it will mark the highest concentration of buy recommendations recorded in the index since at least 2010. Sector-specific sentiment highlights communication services and information technology leading the pack, with both sectors boasting 70% buy ratings, followed by materials (64%), energy (64%), and healthcare (61%). Conversely, consumer staples lag behind, securing a mere 45% buy recommendation rate alongside a sector-high 7% sell rating.
Ultimately, market participants face a complex environment characterized by solid operational results overshadowed by challenging valuation dynamics and attractive alternative yield avenues, mandating active management and rigorous stock selectivity moving forward.
