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Investors are increasingly worried that a recession is brewing (our latest CIO Insights has our take on that) and jittery about how high US stock valuations have become. So it’s an excellent time to take a hard look at the latest earnings season.

At this point, more than 90% of the S&P 500’s companies have provided their second-quarter updates – and the results paint an interesting picture of Corporate America.

On one hand, 59% of them reported revenues that exceeded estimates, short of the ten-year average of 64%. On the other, 78% reported better-than-predicted earnings per share (EPS) figures, above the ten-year average of 74%.

When firms perform better across earnings than revenue, it suggests that profit margins are improving. FactSet’s “blended” S&P 500 data, which combines actual results and estimated, has last quarter’s profit margin figure at 12.2%. That’s higher than the previous quarter and the same period last year.

As far as profit growth is concerned, FactSet’s calculations suggest that EPS in the second quarter were 10.8% higher than the same time last year. That marks the fastest pace of earnings expansion for firms in the S&P 500 since the end of 2021.

“The Magnificent 493”?

This earnings season also reveals a long-awaited profit recovery for the companies that were left out of the AI frenzy. The Magnificent Seven – the biggest of the big US tech firms – have been driving most of the S&P 500’s earnings growth lately. Take those seven out, and the rest of the index’s profits have actually shrunk year-over-year for the past five quarters.

But things may be looking up now: earnings for the other 493 companies are estimated to have grown by 7.4% in the second quarter, compared to the same time a year ago. Profits for the Magnificent Seven, meanwhile, are set to rise by 35%. It's a solid pace, but it marks a slowdown from the even bigger gains seen over the past year.

As an investor, what’s the takeaway here?

Earnings reports are just one piece of the economic puzzle – they should inform, not dictate, your investment decisions. Having said that, improved profit margins and a broader earnings recovery does point to a healthier market that isn't overly dependent on a handful of tech giants.

That, in turn, highlights the importance of diversification beyond just a handful of top performers – something which our General Investing portfolios are designed for.

📰 In Other News: The Federal Reserve cut to the (interest rate) point

At the US central bank’s annual conference in Jackson Hole, chair Jerome Powell said “the time has come” to start cutting interest rates. With inflation now within striking distance of its 2% target, the central bank has a new priority: to stop the labour market from deteriorating.

The Fed has two goals here: to maintain stable prices and to maximise employment. If the central bank waits too long to lower interest rates, higher borrowing costs will take a bigger toll on the economy and the labour market. With the chair’s latest remark, it’s likely we’ll see a cut at the next Fed meeting in September – and that’s what most traders are betting on.

📖 A Little Context: The Magnificent Seven

A nod to the classic 1960 Western film, the "Magnificent Seven" is a term coined by Wall Street to describe seven of the largest technology companies in the US. At their massive sizes, they can have a strong influence on market trends.

It’s worth noting that this group can change over time as fortunes rise and fall. Wind the clock back to 2013, and you'd find a very different set of corporate titans, with oil giant ExxonMobil as the world's most valuable company. Today, Apple is valued at over $3.4 trillion – almost double that of the entire S&P 500 energy sector.