One of the strongest S&P 500 earnings seasons on record is running headfirst into a wall of valuation anxiety, leaving investors wondering whether it's time to take some chips off the table—even as profits soar.
Just a day after markets hit fresh highs, Tuesday's brutal selloff in tech and AI-linked stocks flipped the mood fast.
Palantir Technologies Inc. (NASDAQ:PLTR), the latest star of the AI boom, fell nearly 8% despite raising guidance and crushing earnings estimates. By Wednesday morning, the stock slid another 4% as investors continued to flee overstretched AI-linked names.
So what gives? Why are stocks falling when earnings are this good?
Yes, Corporate America Is Killing It
The numbers don't lie.
According to Wall Street veteran Ed Yardeni, third-quarter earnings are among the strongest ever.
As of Tuesday, 72% of S&P 500 companies had reported. The blended EPS hit $70.65, up 6% quarter over quarter from the second quarter's record and beating analysts' estimates by a whopping 10.5%, the biggest surprise since 2021.
Nine straight quarters of year-over-year growth.
Ten of eleven sectors are growing earnings.
Five sectors are posting double-digit gains.
Information technology alone is up 25.3% in earnings year-over-year. Real estate and financials aren't far behind.
Even the much-hyped Magnificent Seven – minus Nvidia Corp. (NASDAQ:NVDA), which hasn’t reported yet – delivered a 26.8% earnings jump—nearly triple the expected pace.
Amazon.com Inc. (NASDAQ:AMZN) grew earnings by 36.4%, Alphabet Inc. (NASDAQ:GOOGL) by 46.2%, and Microsoft Corp. (NASDAQ:MSFT) by 25.2%.
Across the board, it’s been a blowout season—hardly the kind of business environment you’d expect to trigger a market selloff.
So again—why the drop?
Because Valuations Are A Problem
The answer might be simple: Wall Street already knew earnings were going to be great. These stocks were priced for perfection. Now that perfection is here, there's nowhere else to go but… sideways?
The Shiller CAPE ratio, a long-term valuation metric, is flashing red. It just hit 40.95, the highest since the dot-com peak in December 1999, and well above levels seen even before the Great Depression.
The long-term average? Closer to 17. At these levels, history suggests caution.
"We believe today's valuations might serve as a helpful indicator of longer-term stock market performance,” said Phil Wool, chief research officer at Rayliant, in a recent report.
Wool cited Shiller's data showing that when CAPE exceeds 30, returns over the next 10 years have typically been flat or in the low single digits.
Is The AI Party Slowing Down?
There's another wrinkle. According to Jon Hartley, an economist and Hoover Institution policy fellow, AI adoption data might be plateauing.
In a recent post on X, he shared research suggesting a slowdown based on Ramp subscriptions, Census firm surveys, and worker polling.
If AI is the engine powering today's sky-high valuations, investors will need a true productivity revolution.
Without it, earnings growth won't be able to keep up with soaring prices. If artificial intelligence fails to deliver a transformational and lasting impact, stretched valuations will have to come back down—and history shows that process is rarely painless.
Still, there's a catch: valuation metrics like the Shiller CAPE are not timing tools. Markets can stay expensive longer than traders can stay solvent—or patient.
But over the long run, they've proven to be reliable indicators of future returns.
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