Extraordinary Expectations

While folks focus on market rotation, it's missing the forest for the trees. Markets are pricing in extraordinary outcomes as certainty on an economy wide level regardless of how it’s divvied up.

Rotation has been one of the biggest themes to kick off the second half of the year, with momentum names underperforming the broad market and equal weight outperforming cap weighted. The shifts have created a lot of pain for stock pickers following the momo trends, particularly those claiming to be perfectly market and factor neutral.

Many macro analysts see rotation in equity price movement as a sign that performance is “broadening out,” a lazy inference that real economy companies may be better off in the near term than concentrated gains in the AI+Semi high fliers. But really all this rotation is more a question of which companies are getting what share of the economy wide earnings pool ahead.

The far more interesting macro question is whether the earnings pool can be anything close to what is currently expected at the aggregate level. Because despite all the shifts that have occurred in recent weeks in the market action, expectations of economy wide earnings continue to surge in aggregate.

Sure the first quarter was a stellar one, that surprised to the upside for many reasons, but in the end it was mostly energy names and tech earning surging as commodity prices surged and AI names pulled forward gains.

But for the equity bulls, that stellar quarter was not a one-off surge, but the foundation of even faster earnings *growth* ahead. Over the next 3 quarters, analysts are now expecting earnings to grow at a 31% annualized rate, a magnitude not seen in history other than coming out of acute recessions. Analysts expect another 20% growth in 2027 on top of it. And these expectations are pushing to new highs!

While focusing on the rotation is useful for filling air in the mainstream financial media, it’s the very definition of losing the forest for the trees. The much bigger story coming into the second half is simple: An extraordinary outcome is priced in as consensus.

A Look At The Numbers

Quarterly earnings growth expectations continue to rise to kick off the second half of the year. While 1Q26 clearly surprised to the upside, its notable that we are seeing later quarters pencil out pretty extreme additional increases. For instance 4Q26 earnings numbers suggest a 31% annualized growth rate over 1Q26. (h/t to Yardeni’s free charts through the piece, with my own annotations).

And its not just growth in ‘26. Analysts expectations for ‘27 growth are penciling out another near 20% growth on top of what is expected to be extraordinary growth in 2026.

This surge in growth is expected to come from both an increase in earnings and an expansion of margins. At this point we are looking at topline growth expectations of near 10% over the next 2 years and double digit growth in margins on top of it.

Revenue growth of around 10% is pretty much at the top of historical growth numbers, with most stellar revenue growth periods coming out of recessions (other than the tech bubble of 2000).

Taken together, expectations of earnings growth over the next 2 years is truly extraordinary - penciling out a pace not seen in 50 years other than straight out of acute recessions.

Bottom Line

Market returns in the near term are always about how conditions come in relative to expectations. While folks focus on the nuances of the market structure, the much bigger story as we enter the second half of the year is that expectations for forward earnings growth are extraordinarily high.

While of course they could come true, typically when markets price in the extraordinary as consensus disappointment awaits.