The S&P 500 reached a new record high in August, rebounding after two consecutive monthly declines. This surge was underpinned by an exceptionally strong Q2 earnings season, with companies in the index reporting average earnings per share (EPS) growth of approximately 50% year-on-year. The energy, communication services, and consumer discretionary sectors were highlighted as key contributors to this earnings strength [1].
Strategists from National Bank of Canada (NBC) noted that, on a twelve-month rolling basis, trailing S&P 500 earnings are growing at their fastest pace in a generation, excluding post-recession rebounds. However, they cautioned that forward EPS expectations, particularly in the Information Technology sector, are highly demanding, with more than 40% EPS growth anticipated over the next 12 months. Meeting these elevated earnings guidance targets will be crucial for sustaining the index's momentum [1].
Despite the robust earnings backdrop, the S&P 500 faces valuation risks. Forward price-to-earnings multiples remain around 20, resulting in a low earnings yield relative to elevated long-term U.S. Treasury yields. This dynamic has pushed the equity risk premium into negative territory for the first time in over 20 years. NBC strategists warned that while a negative equity risk premium can persist, as seen between 1997 and 2000, the environment becomes more challenging if 30-year bond yields approach or exceed 5.5% [1].
Bond yields are particularly significant for growth stocks, whose valuations are more sensitive to changes in discount rates. These stocks, especially those benefiting from the AI investment theme, have been among the biggest beneficiaries of the recent rally. AI-related companies now represent a substantial share of market capitalization in the United States, as well as in Emerging markets and Japan [1].
CONCLUSION
The S&P 500's record high is supported by exceptional earnings growth, but stretched valuations and a negative equity risk premium pose significant risks. Sustaining the rally will depend on companies, especially in the IT sector, meeting demanding earnings expectations and on the trajectory of long-term bond yields. Investors should remain vigilant as the market environment could become more challenging if yields rise further.