Market Commentary – Optimism Going into Earnings Season
By: Eric Sterner, CFA, CAIA, FRM, CIPM
Chief Investment Officer, Apollon Wealth Management and Apollon Financial
The 2nd quarter earnings season is underway and it’s off to a great start. All six major U.S. banks reported 2nd quarter results, which included strong growth across core revenue lines. As of today, the projected earnings growth rate for the S&P 500 is nearly 25% for the 2nd quarter with ten of the eleven sectors projected to report year-over-year growth. If that projected earnings growth rate holds, it would mark the 7th consecutive quarter of double-digit earnings growth. The incredible earnings story is expected to continue in the 2nd half of this year as well with analysts projecting earnings growth rates of 27% and 24.6% for the third and fourth quarters, respectively. To add to the optimism, the Federal Reserve’s latest Beige Book, which reflects reports from business contacts, showed economic activity improving in 11 of 12 Federal Reserve districts– the most since January 2025.
Of course, investors are paying attention to the Middle East as the US-Iran ceasefire has broken down and fighting has resumed. The temporary ceasefire had produced a welcome June CPI report, but we will most likely see inflation bounce higher in July as oil prices have jumped since the war restarted and gasoline prices have once again eclipsed $4 per gallon. No one knows how long this conflict will last, but it’s safe to say that inflation will most likely remain elevated until the situation is resolved. We do have several disinflationary trends in place including shelter costs slowly decreasing and tariff pass-through effects winding down. The average tariff level has fallen from 11% in the 4th quarter to roughly 7.3% at the end of May. I don’t expect any rate changes at the Fed meeting next week. It’s interesting to note that the first rate move under the last six Fed Chairs was an increase. You would have to go back to 1970 when the new Chairman, Arthur Burns, put through a rate cut under pressure from President Nixon. The length of the Middle East conflict will most likely determine whether the first move under new Fed Chair Kevin Warsh will be an increase or decrease.
As inflation expectations increase due to the unresolved Middle East conflict, so have bond yields. The 10-year treasury yield is currently hovering at its year-high, and if it creeps closer to 5%, that development could certainly cause some headwinds to the bull market.
The US consumer is financially healthy, but it remains a bifurcated story as the lower-end consumer is struggling due to inflation reigniting, while the higher end consumer has generated substantial wealth over the past several years from the markets and housing appreciation. June retail sales increased for the 9th straight month as sales jumped 9.4% on a year-over-year basis. Affordability will most likely be the central theme to the upcoming mid-term elections and I expect market volatility to increase as we get closer to those elections. The job market has been in a low fire / low hire mode for many months, but we see more strength building from the recent job reports as hiring is picking up. Over the past three months, we have seen an average gain of 111K jobs per month compared to an average job growth of roughly 26K per month over last year. It’s also interesting to see in the last nonfarm payroll report a 720,000 decline in the labor force, which reduced the labor-force participation rate to a 50-year low (excluding a few months during the pandemic) and the unemployment rate fell to 4.2% – its lowest level in the past 12 months. As baby-boomers retire and there remains a sharp pullback in immigration, the economy does not need to generate as many jobs as in the past due to a decreasing labor supply.
While S&P 500 valuations are historically rich, they are cheaper as of today than at the beginning of the year as a 17% rise in consensus forward 12-month earnings estimates have exceeded the approximate 10% return. It’s important for investors who are concerned about market valuations to remember that the market landscape has changed. In 1990, manufacturing companies represented 40% of the S&P 500, but today that figure is down to 15%. Asset-light companies (those less dependent on physical assets to generate revenue) grew from 25% to 55% of the S&P 500. That change is significant since asset-light companies typically have more predictable earnings growth, higher margins, and stronger cash conversion, which can justify higher valuation multiples.
Over the past several weeks, we have seen a strong market rotation. Technology had an incredible 2nd quarter with a return over 37%, but we’ve seen some selling off in that sector recently. I view that development as a positive for the market as the rally is broadening to other sectors and asset classes. It’s very healthy to see these drawdowns before any bubbles build up. While I still believe we are in the early innings of this AI revolution, there are other sectors besides Technology benefiting, such as Industrials, Utilities, and Materials. The broadening not only applies to market returns, but also to earnings. While the Mag 7 is projected to report 31.1% earnings growth for the 2nd quarter, the “other 493” is expected to report earnings growth of 22.8%, which would be the highest growth rate for those companies in 4 ½ years. In fact, it’s expected, as of now, that the “other 493”’s earnings growth rate in the 4th quarter will exceed the Mag 7’s earnings growth rate.
Source – FactSet Earnings Insight, July 17, 2026
Here are some areas of the market I’m very focused on.
- Healthcare / Biotechs – I believe the next sector to enjoy the AI tailwinds will be Healthcare as AI may greatly expedite the drug discovery process for biotechs as well as improve the economics. Recent success stories with AI models are enabling drugs to be targeted to specific illnesses with far greater precision than was previously possible. I’m also bullish on Healthcare as I expect the strong M&A activity this year to continue as pharmaceutical companies acquire biotech firms to fill up their pipelines. In the first half of 2026, there have been $236 billion in announced US healthcare M&A, which is a 90% increase relative to first half of 2025 and the strongest start to a year since 2021. From May 1 through 7/21, the NASDAQ Biotechnology index is up 11.96%.
- Small Caps – The Russell 2000 has returned 23% in the first half of 2026 and 41% during the past 12 months, its strongest returns since the COVID rebound. The AI trade has been a major driver of recent small-cap strength. AI infrastructure stocks have contributed roughly 40% of the YTD return for the Russell 2000. Biotechs have also been a driver by contributing 10% of the YTD return. The resilient economy should continue to provide tailwinds to small caps as should earnings growth expectations of nearly 40% for 2026. However, it’s worth noting that due to the Russell’s reconstitution at the end of June, the weight of AI infrastructure stocks has declined from 15% to 7%.
- Financials – In addition to M&A activity, we are expecting a historic year for IPO issuance, which should benefit the Financials sector along with deregulation. Year-to-date, announced US M&A activity has totaled $1.2 trillion, which is 32% higher on a year-over-year basis. During last week’s major banks’ earnings calls, loan provisions and non-performing loans showed a decline compared to last quarter, which shows that stress in the private sector is falling. Additionally, loan growth as measured by bank credit, total loans and leases, and loans to commercial firms is increasing across the board indicating that credit is being extended. While this sector had been slightly held back earlier this year due to private credit concerns, I believe those concerns are overblown and that area of the market remains healthy.
Financials and Healthcare had been the two worst performing sectors for the year as of the end of April. However, since the beginning of May, Healthcare and Financials have been the second and third best performing sectors, respectively, only trailing Technology.
On the international side, I remain bullish on Japan and emerging markets. Japan still has strong tailwinds due to their corporate governance reforms and AI infrastructure buildout. Japan’s exports rose 17% year-over-year in May, extending a nine-month streak of gains, which has been aided by the weakening yen. I also like emerging markets due to their technology and semiconductor sectors as well as commodity-exporting countries. Analysts are now expecting emerging markets’ earnings growth to be 54% for 2026. Semiconductors and hardware earnings have contributed 80% of emerging markets earning growth and 60% of Japan’s earnings growth so far this year.
Finally, there’s a lot of investor excitement over the mega-IPOs this year. I would express some caution as IPOs typically have higher volatility than other stocks. In fact, since 2006, the 20 largest US IPOs have experienced an average 1-year post IPO maximum drawdown of 61.8%.
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