The third-quarter financial reporting season kicked off this week. As results are gradually being released, what the market has been looking forward to is also coming to light: another “strong” quarter for profits of companies in the S&P 500 index.

On Tuesday, as investors bet that capital expenditures in artificial intelligence – a force that is crucial for both the market and the economy – would not be disrupted by higher bond yields, the market closed at a record high. Assuming key companies provide optimistic guidance, coupled with a bit of support from the bond market, earnings reports could propel the stock market to end this year with a strong performance.

From an index perspective, profit growth should be quite impressive. FactSet summarizes the general expectations, which indicate that analysts predict that S&P 500 earnings will grow by nearly 30% year-over-year, higher than the 26.7% estimated on June 30th.

Of course, the technology sector is key, accounting for about 40% of the S&P 500. If profit forecasts were to be lowered, that would be concerning, but the current trend is quite the opposite. FactSet points out that driven by companies such as NVIDIA and Micron Technology raising their forecasts, the estimated earnings per share ( EPS ) growth rate for the technology sector has risen from 57% on June 30th to 65% today.

In fact, the strong performance of AI chip manufacturers and other large technology companies has alleviated some concerns about a cycle peak. Micron delivered an outstanding quarterly report, which is a positive sign for the broader demand for AI chips. On the consumer side, the launch of Muse and agent by Meta Platforms has sparked a competition to AI that powers consumer e-commerce.

The key point is that profit growth is spreading beyond the "Big Seven." Russell Investments states that although these companies are expected to grow by an average of 20%, the remaining 493 stocks in the S&P 500 are projected to achieve a year-over-year increase of 27%.

In addition to large-cap stocks, profit growth also appears to be healthy. Yardeni Research Chief Economist Ed Yardeni pointed out that the operating profits of mid-cap stocks in the S&P 400 are expected to grow by 19% in 2026. He added that analysts predict that small-cap stocks in the S&P 600 will see a 21% increase in earnings this year and a 16% increase in 2027.

Barclays strategists stated in a report this week: "The stock market is still reacting to earnings." They wrote that S&P 500 profits are expected to grow by 30% this year, and added, "The period from 2025 to 2027 will be the fastest three-year earnings growth period for many in over a decade (excluding rebounds after recessions)."

UBS also sent out optimistic signals. Ulrike Hoffmann - Burchardi, the Chief Investment Officer for the Americas and Head of Global Equities at UBS's Chief Investment Office, stated in a report on Wednesday: "Investors should continue to maintain their positions for a market upward trend; we predict that the S&P 500 will reach 8,400 points by next June."

Is there trouble beneath the surface?

Indeed, stocks other than the "Big Seven" and major chip manufacturers do indeed need financial reports to boost their performance. The issue of market breadth is worsening. Morgan Stanley stated that as of the end of September, only about 20% of stocks were trading above their 50-day moving averages, down from 70% at the height of summer.

Apart from these giants, many stocks are struggling during their respective bear markets. Among the 504 stocks in the S&P 500, nearly 38% have fallen by at least 20% from their 52-week highs. Companies that have seen a decline of at least 50% include CoStar Group, AppLovin, Boston Scientific, Oracle, and Coinbase Global.

From a sector perspective, the situation is not entirely optimistic. Although all sectors of the S&P 500 are expected to experience growth, since June 30th, the bottom-up earnings per share forecasts for 8 sectors have been lowered. Among them, the materials sector has seen the largest decline of -10.2%, followed by consumer staples at -4% and healthcare at -3.3%, according to FactSet.

Even if index profits perform strongly, rising bond yields could disrupt the situation. The yield on 10-year U.S. Treasury bonds has just reached a 24-year high, surpassing 5.36% from 4.75% in August. Part of this increase reflects strong economic growth, but it also indicates persistent inflationary pressures. The Federal Reserve's preferred core inflation rate was 3% in August. If the economy does not fall into recession, it may still be necessary to raise interest rates several more times to bring inflation closer to the Fed's target of 2%.

Rising interest rates will suppress high-dividend sectors such as utilities, essential consumer goods, and real estate. Banks may also feel the impact, as their fixed-income portfolios could incur losses on their balance sheets.

Currently, rising interest rates are not yet sufficient to weaken the AI trades and other factors that drive profit growth. Barclays strategists believe that the market may even be indifferent to a one-percentage-point increase in interest rates. They wrote, "If profit growth is 30% and real interest rates rise by 100 basis points, then profit growth (if not already reflected in prices) still holds the upper hand." They stated, "The stock market understands this—this is why stocks stubbornly refuse to fall."

Investors should pay close attention to the major banks that will release their financial results next week, as these reports will provide insights into how higher interest rates will affect lending, mergers and acquisitions activities, and the IPO pipeline. JPMorgan Chase, Goldman Sachs, Citibank, and Wells Fargo will release their results on October 13th.

In addition, the financial report will also test the market's relatively high valuation multiples. Although the forward price-earnings ratio of the S&P 500 has dropped to around 19 times, Bank of America stated that the index is still "expensive" on 17 out of 20 valuation indicators, and pointed out that this implies an annualized return of -3% over the next 10 years.

As for short-term positioning, Bank of America stated that its momentum and value models favor sectors such as energy, technology, and communications services.

Jefferies prefers sectors with improved profitability and "macro support," believing that finance, healthcare, technology, and materials will benefit.

For the stock market to continue to rise before the end of the year, several things must happen simultaneously: large technology companies, banks, and other key enterprises need to exceed Wall Street's expectations; bond yields need to stabilize; oil prices need to fall, preferably supported by a peace agreement with Iran, to be well below $100 per barrel.

If all of this can be achieved, the stock market should end this year with a strong performance.