The setup: Stocks are expensive again

Over the past year, global stock markets — especially in the U.S. and India — have soared. The S&P 500, Nasdaq, and Nifty 50 have all hit fresh highs, powered by themes like artificial intelligence, green tech, and digital transformation.

But that rally has also sent valuations well beyond historical means. A lot of blue-chip technology companies are trading at 25–30 times their annual revenues; emerging markets’ mid-cap and small-cap stocks are even more expensive.

In plain terms: investors are paying now for earnings that might or might not happen tomorrow. That’s where the earnings growth issue becomes important.

 What earnings growth actually means

Growth in earnings isn’t about how much money companies are making — it’s about how rapidly profits are growing in relation to expectations.

When prices rise higher than earnings, the “price-to-earnings” (P/E) multiple expands. That’s not necessarily negative — it can be a sign of optimism about the future of innovation or productivity gains — but when earnings underwhelm, valuations can drop hard even in the absence of a severe crisis.

Consider it this way: the market is a referendum on faith in the future. Earnings are the moment of truth.

 The numbers tell a mixed story

Up to now, corporate earnings have been good, but not great.

In the United States, the market is led by tech behemoths. Big-name companies such as Nvidia, Microsoft, and Apple are registering record profits, led by AI demand, cloud expansion, and software subscriptions. But beyond that exclusive club, earnings growth has been minimal — particularly in retail, real estate, and manufacturing.

In Europe, margins are still squeezed by energy prices and decelerating demand.

Corporate profits in India have beaten most peers, driven by robust domestic consumption and infrastructure outlays. Analysts caution, however, that midcap valuations — some above 50x earnings — are difficult to defend unless profit growth picks up sharply.

This has created what analysts refer to as a “narrow earnings base”: there are very few mega companies propelling the numbers, but the rest of the market is behind.

 Why it matters: Valuations need fuel

Growth in earnings is the “fuel” that maintains valuations sustainable. Without it, markets rely on sentiment, liquidity, or policy support — all of which can shift overnight.

Currently, several elements are complicating that math:

• Slowing global growth: China’s slowdown, weaker European demand, and frugal U.S. consumers may limit corporate revenue growth.
• Rising costs: Wages, energy, and funding costs remain high. That constricts margins even when sales increase.
• Strong dollar (or rupee volatility): Currency fluctuations can be damaging to exporters’ profits.
• AI investment cycle: While AI is a sustained growth driver, near-term expenditure on chips and R&D is enormous — devouring profits for most companies.

Unless earnings grow rapidly enough, valuations can’t remain this bloated indefinitely. Markets might plateau — moving sideways as profits “catch up” — or correct downwards to rebalance expectations.

The psychology of optimism

Here’s the human element: investors hope to think that earnings will catch up with prices. The pain of missing previous tech manias — or underestimating the power of AI — makes people more likely to pay a premium for growth.

This isn’t irrational; it’s emotional economics. When people witness trillion-dollar firms doubling earnings, they think the tide rising will lift all boats. The risk is that the tide too often won’t reach all shores.

History demonstrates that euphoric valuations periods end not due to calamity, but merely because growth decelerates to the norm. Investors understand that even fantastic companies can’t grow earnings 30% a year indefinitely.

Can growth really deliver?

There are sound reasons to be hopeful:

• AI and automation may realize productivity gains across the board.
• Lower interest rates (once the central banks begin cutting) will cut financing costs and spur investment.
• Emerging markets, particularly India and Southeast Asia, are experiencing healthy demographic and consumption tailwinds.
• If they hold, earnings growth will catch up with high valuations in the next few years.

But timing is everything. If expansion takes longer to arrive — or if world demand slows — markets might reprice hopes at a rapid pace. The take from history (dot-com, 2008, 2021) is unmistakable: once valuations become too far out in front of profits, reality ultimately reasserts itself.

The bottom line

Currently, profit growth partly underpins stock prices today but not entirely. The upsurge is more fueled by faith in profits tomorrow than by the balance sheets of today. It is not a sign that a crash is imminent — it is simply a “priced for perfection” moment when even minimal disappointments have the potential to cause volatility.

Best-case scenario? Corporate profits increasingly gain traction, particularly beyond the tech behemoths, to permit valuations to return to normal without a stinging correction.

Worst-case scenario? Expansion falters, central banks remain vigilant, and markets must reprice hope into reality.

Short and sweet:

• Profits growth is nice — but expectations are nicer.
• Markets are currently wagering big on the latter.