With the new round of financial reporting season underway, the strong upward trend of the US stock market this year may face its biggest test. According to data from Bloomberg Intelligence, analysts predict that companies constituting the index will announce their weakest performance in the past four quarters, with third-quarter profits only expected to grow by 4.3% year-on-year.$S&P 500 Index (.SPX.US)$Component companies are expected to report their weakest performance in the past four quarters, with profits in the third quarter growing by only 4.3% year-on-year.

Despite the decline in profit expectations, the S&P 500 index hit a new high again last Friday, with a cumulative increase of 22% year to date in 20204. Investors who are bullish on US stocks may have a point, as if these downward revised expectations prove to be too pessimistic, there seems to be room for profit surprises to the upside. This situation occurred in the first quarter, when profit expectations were expected to grow by 3.8% year-on-year, but the actual result was an increase of 7.9% year-on-year.

Baird investment strategist Ross Mayfield said: "The extent to which analysts are lowering earnings per share expectations is greater than usual, which may increase the probability of outperformance and lead to better stock market performance."

Here are five key themes that investors should pay attention to in the third quarter earnings season:

1. Slowdown in profit growth for tech giants

Most of the profit growth of companies included in the S&P 500 index still comes from large technology companies, which are considered the primary beneficiaries of artificial intelligence development. The so-called "Big Seven" of the US stock market - Apple, $Microsoft (MSFT.US)$and$Alphabet-A (GOOGL.US)$N/A.$Amazon (AMZN.US)$,$NVIDIA (NVDA.US)$and$Meta Platforms (META.US)$And$Tesla (TSLA.US)$Profit in the third quarter is expected to increase by 18%. However, according to data from Bloomberg Intelligence, the issue is that the profit growth of these tech giants is slowing down, below 30% in 2023.

In addition, the data shows that the profits of other constituent companies in the S&P 500 index, apart from the 'Big Seven', are expected to grow by 1.8% in the third quarter, marking the second consecutive quarter of growth, albeit small. Bloomberg Intelligence data shows that profit growth of the remaining 493 constituent companies in the S&P 500 index is expected to accelerate significantly from now on, with double-digit growth expected in the first quarter of 2025.

2. Investors' Paradise

Investors may expect some individual stocks to experience significant fluctuations that would not be reflected in the overall market index. The options market is pricing the largest average performance implied volatility at the single-stock level since Bank of America began collecting data in 2021. However, Bank of America stock strategist Ohsung Kwon states that at the index level, the implied volatility is relatively low, indicating that this earnings season could be a 'paradise for stock pickers'.Implied volatilityrelatively low, indicating that this earnings season could be a 'paradise for stock pickers'.

Among the 11 sectors of the S&P 500 Index, three sectors - technology, communications services, and medical care - are expected to see profit growth of over 10%. On the other hand, the energy sector is expected to report a decline of over 20%. Gina Martin Adams, Chief Stock Strategist at United Kingdom Business Banks (BI), stated that due to the sharp drop in crude oil prices last quarter, the energy sector is expected to see the largest decline in profit expectations among the 11 sectors.

3. Profit Margin

Wall Street professionals will closely monitor profit margins, a key indicator of measuring the effectiveness of a company's profitability. Data shows that the profit margin for the third quarter is expected to decrease to around 12.9%, lower than the 13.1% in the second quarter, but slightly higher than the 12.8% in the third quarter of 2023. This slight decrease reflects the challenges some companies face in passing input costs on to consumers, as wage pressures still exist in some low-productivity industries where automation is difficult to achieve.

Bloomberg Intelligence data shows that the energy and real estate sectors will have the lowest profit margins, but from a broader perspective, a rebound is expected over the next several quarters.

4. Turbulent European Markets

In Europe, the new round of earnings reports may mark a turning point for the pan-European Stoxx 600 Index, which is currently hovering near historic highs. Analysts have lowered profit expectations for the index's constituent companies due to sluggish economic growth in the Eurozone.

Although lowering the profit expectations has lowered the threshold of exceeding expectations, the expectations for 2025 are still very high. Any indication of weakening consumer demand will force these forecasts to be lowered, which will further impact the company's stock price. Many well-known companies, including Swedish outfitters Hennes & Mauritz AB and Volkswagen, have issued profit warnings in recent weeks.

5. Election Focus

With just weeks left till the US elections, investors will be listening to corporate executives' views on economic and trade policy risks, as well as other political issues. Data from Bank of America shows that about 110 companies mentioned the term "elections" in their second-quarter earnings conference calls, a 62% increase from four years ago.

Bank of America stock strategist Ohsung Kwon stated that history indicates corporate investment activities tend to accelerate after US elections, which could be a catalyst for companies to release capital in the coming quarters, especially in a scenario of decreasing interest rates.

However, companies may also delay some expansion plans and other expenditures. LPL Financial's Chief Stock Strategist Jeff Buchbinder said, "Today, so much capital investment is related to artificial intelligence that the elections are unlikely to hinder this. However, with the elections so close and due to the political uncertainty, some more traditional capital commitments may be postponed."

Editor/rice