Deutsche Bank released a preview report on third-quarter US corporate earnings, stating that the multiple tailwinds that drove the S&P 500's earnings growth to a record 34% in the second quarter remain strong in the third quarter, and it expects the growth rate to hold at 34%, with no slowdown in earnings growth.

By contrast, the market consensus expects third-quarter growth of 26.7%, implying a deceleration of 7.5 percentage points from the second quarter. The bank's forecast is about 6 percentage points above consensus, while the average earnings beat over history has been only 3.3%, and the bank believes this season will again deliver an above-average beat.

Three tailwinds working together

The bank noted that the earnings boom stems from three tailwinds firing simultaneously: accelerating AI demand growth, up 54% year on year, contributing 20 percentage points to overall growth; a rebound in cyclical growth, at 14% excluding technology, energy and materials, contributing 8 percentage points; and higher oil and commodity prices, driving 108% earnings growth in energy and materials and contributing 7 percentage points.

It should be noted that the 34% growth rate has been adjusted to strip out one-off items such as Alphabet's asset sale gains and unrealized gains on Amazon's investments; before adjustment, growth was as high as 53%.

Three key disagreements between Deutsche Bank and the market

No sign of AI demand slowing

On whether AI demand can continue, the bank said multiple indicators show third-quarter AI demand growth remains very strong. It cited South Korean semiconductor production and export growth accelerating further from the second quarter to the third, while rising GPU rental prices indicate supply and demand remain very tight.

South Korean semiconductor export growth rising

The bank expects AI demand to keep earnings growth for mega-cap growth and technology names at a high of 54% in the third quarter, and as their weight in S&P 500 earnings rises, their contribution to overall growth will increase from 19.5 percentage points in the second quarter to 21 percentage points.

Cyclical growth accelerating further

Deutsche Bank noted that a large number of indicators show cyclical growth strengthening further in the third quarter. The US ISM manufacturing index rose sharply in the third quarter to its highest level in four and a half years, and this gauge has historically been the best cyclical leading indicator for S&P 500 earnings growth.

US ISM manufacturing index rising

Macro consensus shows US GDP growth accelerating from 2.2% in the second quarter to 2.8% in the third quarter on an annualized quarter-on-quarter basis, while the Atlanta Fed's tracking estimate is as high as 3.7%. In addition, retail sales, industrial production and capital goods shipments growth remain strong, and cyclical employment has continued to recover since bottoming in February.

Limited lagged impact from oil prices, tariff refunds add further support

As for the lagged negative impact of high oil prices, the bank views it as still mild and concentrated in specific sectors. It said that historically the impact of oil price shocks on earnings of other S&P 500 sectors lags by two to three quarters and is usually modest, because most companies respond by raising prices and improving productivity. Airlines, autos and some consumer sectors are hit faster and harder, but earnings expectations for these sectors have already been sharply revised down since the Iran war began: airlines down 17%, autos and packaging each down 9%, and travel excluding airlines down 6%.

In addition, after the Supreme Court ruled IEEPA tariffs invalid, companies continue to receive tariff refunds, which the bank expects will contribute about 2 percentage points to overall third-quarter earnings growth, just as in the second quarter.

Earnings season plus midterm elections, favorable risk-reward into year-end

Deutsche Bank emphasized that earnings season has historically been good for stocks. Since the financial crisis, the S&P 500 has risen in three out of four earnings seasons, with an average gain of 2%, and this pattern has been even more pronounced over the past year. Although this season coincides with the late-October FOMC meeting and the early-November US midterm elections, which could bring extra volatility, historical patterns show markets tend to move sideways or weaken before major risk events land and rebound afterward.

The bank also noted that risk-reward in the fourth quarter of midterm election years has historically been very favorable: in 21 of the past 23 election years, the S&P 500 rose in the fourth quarter, with an average gain of 7%. Overall, the bank believes the current risk-reward for US stocks remains favorable.