Are excessive profits becoming "poison"? The U.S. stock market has revealed a paradox of growth, and Wall Street warns that peak valuations could bite back at any moment.

Notably, there is a rather absurd reason for concern regarding the U.S. stock market at the moment: profit growth is too strong. As the latest earnings season draws to a close, all signs indicate that the second quarter has been one of the best three-month periods in recent memory, with a profit growth rate exceeding 30%. The only question is? This hot momentum is likely difficult to sustain. Bank of America strategists have noted that there are widespread expectations for growth rates to drop below 20% by the first quarter of 2027, followed by a slowdown to around 15% over the course of the year. While this growth rate still appears healthy from a historical perspective, markets often struggle to maintain equivalent support when profit growth declines from elevated levels. This pattern could push next years stock market into one of the most vulnerable phases for U.S. stocks: according to Bank of America data, when earnings per share (EPS) growth is above trend levels but is slowing down, the median 12-month return for the S&P 500 index is 6.7%, with a 72.3% probability of increasing. In contrast, when EPS growth is above trend and continues to accelerate, the median return jumps to 14%, with an increase probability as high as 83.3%. Outstanding Profit Growth However, there is actually very limited historical data regarding this explosive profit growth seen this year. A team of strategists led by Savita Subramanian at Bank of America anticipates that growth in the third and fourth quarters will remain above 20%, marking four consecutive quarters of surpassing that threshold. Such a streak is quite rare and has only occurred 10 times since 1936. Strategists pointed out that the recent occurrences have taken place following a decline in EPS, such as during the COVID-19 pandemic and the global financial crisis. Moreover, the growth rate is not the only standout statistic from the second quarter earnings season. According to Citadel Securities, profits for S&P 500 constituents are also on track to achieve one of the largest beats against analyst expectations on record. Scott Rubner, head of stock and equity derivatives strategy at the firm, noted that companies have also driven the strongest profit upgrade trajectory in at least 26 years. Rubner wrote in a report released on Tuesday, Importantly, this is not just a story about AI, adding, The macroeconomic discussion remains complex, but the message coming from American corporations is much simpler: profits exceeded expectations, and by a huge margin. Data shows that as of Fridays close, 85.6% of companies overall surpassed Wall Streets EPS expectations, the highest proportion since 2021. Additionally, only 10.6% of companies failed to meet expectations, the lowest figure in thirty years. The current looming question is: is this the peak? Ben Inker, co-director of asset allocation at GMO, stated that the profit performance in the second quarter was exceptional. However, there is a divergence between the AI sector and the rest of the market. Much of the latters strong profits can be attributed to a cyclical rebound. If the momentum continues, it is very likely to push up inflation and interest rates; however, if the momentum stalls, corporate performance may disappoint relative to the upwardly revised forecasts, Inker said. Despite analysis from Bespoke Investment Group showing that companies are raising their growth expectations at the fastest pace in 25 years, the firm is remaining cautious and wary of extreme scenarios. Noah Weisberger, chief U.S. equity strategist at BCA Research, believes that the elevation of analyst expectations and companies own performance guidance increases the likelihood of localized overheating, but he added that a profit growth expectation reaching the lower range of 10%-15% by 2027 seems achievable. However, with interest rates remaining high and a significant influx of stock supply expected as more AI companies go public, reaching a peak in profit growth is a precarious moment. Given that valuations are elevated and the IPO wave still needs to be absorbed by the market at current valuation levels, the bond market remains a major source of concern for us regarding the stock market, Weisberger said. At some point, investors will naturally choose not to pay peak multiples for profits at peak times. Investors may be realizing that the bar set for corporate performance in the coming quarters may be too high. Bank of America strategist Jill Carey Hall noted that compared to previous quarters, the market's reaction to exceeding expectations and growth has been muted, indicating that most good news has already been priced in. Western Digital, Datadog Inc., SanDisk, and DaVita Inc. all exceeded expectations in revenue and profits but saw their stock prices sold off. Data shows that among companies whose revenue, profits, or both exceeded expectations, their stock price showed an average one-day excess return that was flat; meanwhile, failing to meet performance targets resulted in more severe sell-offs. Carey Hall stated, Investors have effectively been building positions in anticipation of these positive news and strong earnings, adding, Thus, once stock performance exceeds expectations, the rewards are not as rich as typically seen.