The U.S. stock market looks expensive. But perhaps today’s high prices are justified by future high earnings growth? Analysts are currently predicting that corporate earnings will grow at an annual rate of around 20% over the foreseeable future. Given this glorious growth, shouldn’t we ignore the nattering nabobs of negativism and gaze confidently ahead into the broad, sunlit uplands of bountiful corporate profits?
That’s the view of Ed Yardeni:[1]
We are raising our year-end S&P 500 target ... We've been bullish on earnings but not as bullish as the recent consensus of industry analysts. We've never seen consensus earnings expectations rise so quickly for the current and coming years as they have in recent months.
However, history suggests that high predicted earnings growth is actually a red flag. It’s true that in a world of rational investors and rational forecasters, high forecasts of future earnings would justify high prices. The problem is that today’s forecasts of high growth may be irrationally optimistic. Times when analysts predict high growth are typically bad times to invest in the stock market. The ideal time is when we observe pessimism, not optimism.
The good news on corporate profits has arrived at many different horizons: high realized growth in recent quarters, high predicted short-term growth (over the coming year), and high predicted long-term growth (over the three-to-five year horizon). Here’s Yardeni again, describing long-term growth forecasts: [2]
… expected long-term earnings growth (LTEG) for the S&P 500 rose to 20.2% during the week of May 5 … LTEG now exceeds the 18.6% peak of the 2000 tech bubble.
Analysts are typically excessively optimistic about the companies they cover; on average since 1985, they’ve predicted 13% earnings growth, far above actual growth of about 7% for S&P 500 firms during this period.[3] Today, however, analysts are even more optimistic than usual.
Are these optimistic forecasts plausible? Maybe, but I’ve previously discussed the many ways in which a wonderful AI boom would not necessarily benefit shareholders. Ilmanen and Maloney (2025) describe forecasts as of December 2024 as “mega-cap mega-overoptimism” and remark that “today’s optimism has some reasoning behind it, but double-digit expectations remain as silly as they ever were.”
Bordalo et al. (2024) study long-term earnings forecasts and find that they have
… remarkable power to jointly predict future errors in expectations and stock returns, in both the aggregate market and the cross section. The evidence supports a mechanism whereby good news causes investors to become too optimistic about long-term earnings growth. This leads to inflated stock prices and, as beliefs are systematically disappointed, subsequent low returns in the aggregate market.
So their basic finding is that good realized earnings growth causes irrational exuberance among market participants, who extrapolate the good news into the future. They show that earnings optimism was abnormally high during the tech stock bubble. Their findings suggest that shareholders will be disappointed over the next five years as earnings fail to grow as fast as expected, just as they were after the tech stock bubble.
It remains an open question whether growth forecasts or stock prices are in the driver’s seat. Consider the amazing Korean stock market. Price levels have tripled – tripled! – in the past year. Yet forward P/E ratios have actually fallen during this period, as forward E rose even faster than P. One story is that, due to good fundamental news about Korean technology companies, analysts raised their forecasts of E, and consequently P went up. A different story is that P went up, and analysts scrambled to update their valuation spreadsheets with new E in response.
Perhaps today’s optimism is justified. Stranger things have happened. For example, I thought Tesla was absurdly overvalued as of 2016.[4] Without making any comments about Tesla’s current valuation, it looks like I was wrong in 2016 and the market was right.[5] Over the next five years, from 2016 to 2021, Tesla experienced amazing growth in fundamentals that seemingly vindicated the market’s 2016 optimism. You could argue that Tesla’s high valuation as of 2016 was a triumph of the efficient market hypothesis. So Tesla in 2016 is a counterexample to the tech stock bubble; sometimes, lofty expectations are met.
Perhaps, when 2031 rolls around, we’ll look back and see today’s market valuation as another triumph of the efficient market hypothesis, with 2026 prices being justified by high subsequent earnings over the next five years. Perhaps. But for me, today’s optimism is yet another way in which 2026 is looking like 1999.
Endnotes
[1] “MARKET CALL: Raising Our 2026 S&P 500 Target Range Due To Earnings-Led Meltup,” Yardeni Research, May 10, 2026.
[2] “Earnings-Led Meltup,” Yardeni Research, May 6, 2026.
[3] These long-term forecasts are cap-weighted and use median analyst “expected annual increase in operating earnings over the company’s next full business cycle. These forecasts refer to a period of between three to five years.” The data has limitations. Relatively few analysts provide long-term forecasts in recent years.
[4] References to this and other companies should not be interpreted as recommendations to buy or sell specific securities. Acadian and/or the author of this post may hold positions in one or more securities associated with these companies.
[5] Here is a quote from my 2016 lecture notes for Econ 1760 at Harvard University: “I'd guess investors (stupidly) think Tesla will have high returns.” Mea culpa.
References
Bordalo, Pedro, Nicola Gennaioli, Rafael La Porta, and Andrei Shleifer. "Belief overreaction and stock market puzzles." Journal of Political Economy 132, no. 5 (2024): 1450-1484.
Ilmanen, Antti, and Thomas Maloney. “Objective Expected Returns,” AQR, July 2025.
