How Second-Quarter Earnings Could Push the S&P 500 Even Higher

Traders at the New York Stock Exchange. (Michael M. Santiago/Getty Images)

The stock market is on track to finish the week lower. Earnings season, which begins in earnest next week, should drive it higher.

It’s been an odd week. The S&P 500 index was down 0.2% even after closing at an all-time high on Thursday, while the Nasdaq Composite was up 0.2% after the tech-heavy index got a boost from Nvidia ’s closing at a record $4 trillion market value. The Dow Jones Industrial Average was down 1%.

Record highs and down weeks don’t typically go together, but the declines themselves are relatively minuscule, especially given the tariff headlines generated during the week—the possibility of 50% levies on Brazil and 35% on Canada, among others, if negotiations don’t go well—and continued attacks on Federal Reserve Chair Jerome Powell. The S&P 500, after all, is still up 26% from its April low and has gained 6.4% this year.

Created with Highcharts 9.0.1Market SnapshotSource: FactSet

Created with Highcharts 9.0.1NASDAQ Composite IndexS&P 500 IndexDow Jones Industrial AverageiShares Expanded Tech-Software Sector ETFJuly 7July 11-4.0-3.5-3.0-2.5-2.0-1.5-1.0-0.500.5%

The small declines seem even more surprising given the fact that the S&P 500 trades at 22.4 times 12-month forward earnings, its peak valuation over the past three years. With earnings season starting, any disappointments due to tariffs or other factors could send the market lower.

Earnings probably won’t disappoint. For one, the bar doesn’t seem terribly high. Analysts expect S&P 500 sales to grow 3.8% year over year, according to FactSet, realistic given that the economy is estimated to grow by 2.8% during the second quarter, according to the Atlanta Fed’s GDPNow tool, and an inflation rate that is just over 2%. That sales growth, combined with stock buybacks, is why analysts expect S&P 500 earnings to grow by 5% to $62.59 a share.

Indeed, these estimates could prove conservative. Earnings forecasts have dropped 4% since the end of March, just before President Donald Trump initiated tariffs, with larger estimate declines coming from sectors most vulnerable to tariffs, particularly industrials and retailers. Companies also tend to beat earnings estimates, so the picture is “setting up for beats near historical average rates (5%),” writes Deutsche Bank equity strategist Binky Chadha.

Guidance will be crucial. Some on Wall Street are nervous that outlooks will either disappoint or not be provided because of tariff disruptions, potential or realized. Bad news can cause stocks to tumble— Conagra Brands dropped 4.3% after releasing tariff-disrupted forecasts —but strong guidance also sent Delta Air Lines stock up 12%.

“What you’re seeing out of Delta is a good example,” says Doug Bycoff of the Bycoff Group, an asset manager. “Air travel is getting better into Q3 to create that upside [stock price] effect.”

Earnings should also get a boost from all the spending Big Tech is doing on artificial intelligence. Analysts expect Microsoft, for instance, to report $17.5 billion in capital expenditures during the quarter, up 26% from the previous year, but less than half the previous rate. Much of that spending is tied to data-center investments and will provide a boost to chip makers like Nvidia and companies that help build data centers and other AI infrastructure, but won’t be excessive enough for investors to freak out.

“We’re still building AI with reckless abandon,” says Tavis McCourt, a Raymond James equity strategist. “The players that are involved in the buildout are in a pretty good spot.”

History suggests that the high multiple isn’t something to worry about just yet. When the S&P 500 hit 22 times or higher in the past five years, it gained an average of 4.6% over the following three months, according to Dow Jones Market data. Many of those rallies spanned April, July, and October, the thick of earnings season.

As long as earnings keep growing, so can the market—valuation be damned.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com