Earnings Upgrades Are Historically Anomalous, Yet US Stocks Are Missing the Good News
TREE NEWS reports: US corporate earnings are strengthening at a pace that strategists describe as almost statistically implausible, yet equity prices are failing to reflect the improvement. Patrick Palfrey, head of portfolio strategy at Seaport Research Partners, points out that sell-side earnings estimates are still being revised higher as the quarter progresses — a pattern that runs counter to the historical norm, in which estimates typically peak early in the year and drift lower. “This is almost outside the realm of normal probability — and that tells you just how strong corporate fundamentals are,” Palfrey said.
Second-quarter earnings per share for S&P 500 constituents jumped 55% year over year, and even after stripping out unrealized gains, growth remained a robust 35%. Semiconductor and technology companies drove much of the increase, but Palfrey stresses that the broader earnings environment remains healthy.
Why the Market Isn’t Rewarding Strong Fundamentals
The disconnect comes down to valuation math. High interest rates raise the cost of capital and compress price-to-earnings multiples, which is a key reason valuation multiples have been sliding all year. Investors are also questioning whether the current earnings boom can be sustained, further capping how much they are willing to pay for those earnings.
Palfrey cites the violent swings in software stocks earlier this year as a case study in sentiment-driven mispricing. Investors dumped the sector on fears that artificial intelligence would disrupt traditional software business models — “all companies were found guilty before anyone did due diligence” — only to rotate back in later. Such episodes, he argues, show that mispricing driven by market emotion is far from rare.
Seaport tracks the relationship between three-month changes in earnings-per-share estimates and three-month stock price performance to identify where price moves are justified and where they are not. The clearest dislocation right now appears in industrials and transportation, where fundamentals are accelerating but share prices have not kept pace. One root cause: capital and investor attention have been almost entirely captured by the technology sector. “Technology not only absorbs all the capital investment, it also captures all of investors’ attention,” Palfrey said — meaning other sectors may be leaving undervalued opportunities on the table.
The Fed Is the Biggest Near-Term Variable
Interest-rate risk has moved to the center of institutional conversations. In calls with investors this week, Palfrey found that rate concerns are no longer being deferred with a “wait-and-see” attitude but are being discussed in more substantive terms — rising capital costs, falling multiples, and demographic shifts included.
For the upcoming Federal Reserve rate decision, he warns that even with roughly 60% odds of a hike already priced in, the market could still be caught off guard if the Fed re-emphasizes inflation pressure and the need for further tightening. “I think this will continue to throw cold water on near-term equity markets,” Palfrey said.
Meanwhile, rising oil prices are weighing on US equities, the 10-year Treasury yield has climbed to 4.926%, and investors are largely trading around the artificial-intelligence infrastructure theme with limited sensitivity to macroeconomic data. Should the rate narrative shift, the market’s optimism about earnings fundamentals could be quickly suppressed.
Key Takeaways for Investors
- Fundamentals and prices are diverging: Earnings estimates are being revised up at a historically unusual pace, but high rates are keeping a lid on valuation multiples.
- Look beyond tech: Industrials and transportation show accelerating fundamentals with lagging share prices — potential mispricing opportunities.
- Rates remain the swing factor: A hawkish Fed surprise could overshadow strong earnings and pressure equities in the near term.
- Sentiment-driven mispricing is common: The software episode shows markets can overreact before doing proper analysis, creating entry points for disciplined investors.
