There is something slightly uncomfortable about the US equity market right now. The headlines have become more threatening, yet the corporate earnings story remains remarkably strong.

Oil is above $100 a barrel. The 10-year Treasury yield has moved dangerously close to 5%. The conflict with Iran continues to threaten energy supplies, while investors are asking increasingly difficult questions about the vast amounts of money being poured into artificial intelligence.

Normally, that would be a fairly unpleasant cocktail for equities. Yet the S&P 500 continues to have one very powerful factor working in its favour. Corporate America is still delivering.

That leaves investors facing a tug of war between two very different forces. Strong earnings are pulling the market higher, while geopolitics, oil, bond yields and concerns over AI returns are pulling the other way.

For now, earnings are keeping the bull case alive.

Earnings are still doing the heavy lifting

The latest reporting season provided plenty of ammunition for the optimists.
Of the 492 S&P 500 companies that had reported second-quarter results, 86% beat analyst earnings expectations. That was comfortably above the long-term average of 67.5%. Barclays subsequently raised its year-end S&P 500 target to 7,950, citing the strength of corporate earnings.

Perhaps even more encouraging is what has happened to earnings estimates since then. Analysts usually trim forecasts as a quarter progresses. This time they have done the opposite. FactSet found that the bottom-up estimate for third-quarter S&P 500 earnings rose 1.2% during July and August. Over the past five years, estimates have typically fallen by 1.7% during the same period.

The market is also beginning to look beyond 2026. UBS now expects S&P 500 earnings per share of $350 this year and $400 in 2027. That implies earnings growth of roughly 14%. UBS has also raised its year-end S&P 500 target to 8,100.

This is important because a rising stock market does not automatically mean that shares are becoming more expensive. If corporate earnings increase strongly, share prices can rise while valuation multiples remain broadly unchanged.

That is the heart of the current bull case. There is one obvious catch, though. The earnings have to turn up. If investors are valuing the market on something close to $400 of earnings in 2027 and actual profits fall materially short, today's valuations will suddenly look much less forgiving.

The bond market is becoming difficult to ignore

If earnings are the market's strongest support, Treasury yields may be its biggest immediate obstacle. The US 10-year Treasury yield climbed as high as 4.979% during the latest bond sell-off. It has since eased somewhat, but 5% is now close enough to matter. That level has both practical and psychological importance.

When government bonds offered investors very little income, paying high multiples for equities was easier to justify. A Treasury yield near 5% changes the calculation. Bonds become more competitive with shares, borrowing becomes more expensive and the present value of future corporate profits falls.

It therefore makes sense to be more conservative when thinking about what investors might be prepared to pay for earnings. Using a working valuation range of 19 to 20 times earnings, rather than assuming the market can indefinitely sustain multiples of 21 or 22 times, gives us a more cautious framework.

Apply those multiples to $400 of 2027 earnings and the S&P 500 would sit somewhere between roughly 7,600 and 8,000, with a midpoint of 7,800. That is not a forecast carved in stone. It is simply a useful way of judging how much upside might remain if earnings deliver while higher bond yields continue to constrain valuations.

With the SPX500 closing at 7,597 yesterday, there is still room for further gains if the earnings story holds together. There is just considerably less room for disappointment.

Oil and the AI test

The most obvious threat to that comfortable earnings story comes from energy. UKOil crude settled at $108.94 a barrel yesterday after jumping more than 6% as tanker attacks and disruption around the Strait of Hormuz intensified. Oil eased towards $106 the following day, but remained more than 10% higher for the week.

The danger is not simply a higher petrol bill.

Persistently expensive oil can feed inflation, make central banks less willing to ease policy, push bond yields higher and reduce the valuation investors are prepared to place on equities. That chain reaction is one reason the bond market has responded so sharply to developments in the Middle East.

Then there is AI. The investment boom remains extraordinary, and demand for the infrastructure needed to support it is still strong. The issue is shifting from whether companies will spend the money to whether that spending will generate adequate returns. That distinction will matter more as the numbers get bigger. The result is a bull market that still has a powerful earnings engine but faces increasingly difficult conditions around it. If tensions with Iran ease, oil retreats, Treasury yields fall back and AI investment translates into durable profit growth, the S&P 500 has a credible path towards 8,000 and potentially beyond.

References

• reuters.com
• factset.com
• reuters.com
• reuters.com
• reuters.com
• reuters.com
• reuters.com