S&P 500 companies are expected to report third quarter earnings growth near 28.9% against the same quarter last year. That would be the third consecutive quarter of profit growth above 25%, a run the index has managed only a handful of times in its history.

The index closed at 7,764.70 on September 22, roughly a tenth of a percent below the record of 7,798.99 set in mid August. Since June 30 the expected earnings for the next twelve months have risen 8.8% while the price has risen 1.8%. Profits have been doing nearly all the work, and the market has been giving back most of it in the multiple.

De-rating is not the same as falling

The forward price to earnings ratio now sits near 19.4, down from 20.4 at the end of June and below the five year average of 19.8. A market can become cheaper while going nowhere, which is precisely what has happened this quarter, and it is a healthier pattern than the reverse.

The mechanism is not mysterious. A multiple is the inverse of a discount rate applied to a stream of future profits, and the ten-year Treasury has spent the quarter moving from the low fours to just under 5%. A higher risk free rate lowers what any given stream of earnings is worth today. The Fed's decision to raise to 3.75% to 4% and remove its projected 2027 cuts made that repricing structural rather than temporary.

So the index is absorbing a rate shock with earnings rather than with price. That is the good version of this setup. The bad version is what happens if the earnings stop cooperating while the discount rate stays where it is.

The growth is narrower than the number suggests

Whitmore's Watchlist:
SPY (SPDR S&P 500 ETF Trust): The cap weighted index, where the concentration lives.
RSP (Invesco S&P 500 Equal Weight ETF): The same five hundred companies with the concentration removed.
XLK (Technology Select Sector SPDR Fund): The sector carrying most of the earnings growth and most of the valuation.

Aggregate earnings growth of 28.9% is not a description of the typical company. Energy earnings are running above 100% growth on a year when crude spent much of the period near $100 a barrel. Semiconductor profits are up a comparable amount on the buildout of data centre capacity. A single large technology company is contributing growth measured in multiples rather than percentages.

Strip those contributors out and the remainder looks like an ordinary expansion in the single digits. That is not a criticism of the index, it is a description of what owning it currently means: a concentrated bet on energy prices and on artificial intelligence capital spending, wrapped in a product that most people hold as a diversified default.

The equal weighted version of the same index makes the point cleanly. When the two diverge for long stretches, the gap is a measure of how much of the market's performance depends on a small number of names rather than on broad corporate health.

What would break the pattern

The current arrangement works as long as earnings keep beating and the discount rate stops rising. Two things would change it.

The first is the comparison base. Growth above 25% for three quarters means the fourth quarter is being measured against a very high bar, and the arithmetic alone will slow the reported rate sharply even if business is unchanged. Investors who have learned to expect twenty something percent will be reading a considerably smaller number next winter.

The second is the energy assumption. Crude fell 4.5% to $95.78 on September 21, an eleven day low, after topping $100 the previous week. Energy is the single largest contributor to the current growth rate and it is levered to a barrel price that is being set by a geopolitical risk premium rather than by demand. Whichever way that resolves, it will move the index earnings number more than most people expect.

That is worth holding alongside the cheerful headline. A market trading below its five year average multiple on record profits sounds like value. It is value conditional on those profits, and the profits are unusually concentrated in two stories.

Whitmore's Take: The index has been de-rating while earning more, which is the constructive version of going sideways. Worth checking how much of that earnings growth comes from two sectors before treating the lower multiple as a margin of safety.

Written by Daniel Whitmore
Millionaire Insiders