Q2 Earnings and the Market’s Bubble Risk: A Deep Dive into Profits, Valuations, Buybacks, and Macro Disconnects

The second-quarter earnings season roughly half complete, and the results highlight a market perched on historically rich valuations even as core profit engines slow, buybacks mask tepid real growth, and macro indicators turn fragile. This comprehensive report synthesizes the data released through July 25th to evaluate how stretched the U.S. equity market has become, where cracks are emerging beneath the surface, and what investors should monitor as the year progresses.

Q2 2025 Earnings: Headline Trends

Early reporters show robust beat rates, but the year-on-year earnings growth rate (5.6%) is the weakest since late 2023. Revenue is rising 4.4% nominally, essentially flat after adjusting for the 4.3% drop in the trade-weighted dollar since April, which inflates overseas sales when translated back to USD. 12

The “Magnificent Seven” Effect

The top seven megacap tech names are expected to post Q2 earnings growth of 14.1%, versus just 3.4% for the other 493 firms. Without them, the S&P 500’s aggregate EPS growth would be ~2 percentage points lower. 2

Revenue and Margin Quality

1. 1. Currency Boost: A weaker dollar lifts foreign sales; stripping FX effects, real top-line growth is ~1.5%.

   2. Margin Drift: Net profit margins hover near 12.3%, still elevated but edging down from the 2024 peak of 12.9%.

   3. Input Cost Pressures: Energy, materials and tariff costs are eroding gross margins in Industrials and Consumer Discretionary stocks; EPS strength comes largely from financial engineering rather than operating improvements.

Buybacks: Fuel for Per-Share Growth

Valuations Are Stretched—Even Versus Recent History

Sector Scorecard

Softening Growth Indicators

• • Atlanta Fed GDPNow: consumer-spending contribution to Q2 GDP tracking at 1.0%, down from 2.3% six weeks ago [‘Atlanta Fed’ chart in SA article].

  • Retail gasoline demand: four-week moving average 4.8% below prior-year levels despite 10% cheaper prices [SA article].

  • Conference Board LEI: –0.3% in June, sixth straight monthly drop (discussed July 18)[PSW conversation].

Market Euphoria

• • S&P 500 set 10 record highs in 19 trading days July – mid-July [news article].

  • Call-skewed option activity at highest since 2021; Goldman and Citadel desks urging hedges [news article].

  • BofA strategist Michael Hartnett flags “bigger liquidity, bigger bubble” as global policy rate sinks to 4.4% and expected to fall to 3.9% [article].

Result: A visible gap between equity prices and the real-economy pulse—mirroring late-cycle patterns ahead of prior corrections.

Bubble Checklist

Half the classic bubble signals flash red—most notably valuation, buyback intensity, and retail participation. IPO froth is muted, limiting one hallmark of prior manias, but the cumulative evidence tilts toward late-cycle exuberance.

Risks into the Second Half

1. 1. Fed Hawkish Surprise — If Powell signals “higher for longer” on July 30, duration-valued megacaps could de-rate. This is mitigated, however, by Powell’s limited-remaining term and the near-certainty that Trump will replace him with an extreme dove. 

   2. Tariff Cliff (Aug 1) — Escalation with EU or China would squeeze margins and capex plans, especially Industrials and Autos.

   3. Earnings Misses Outside Tech — Narrow leadership means underperformance in financials, consumer and energy could drag the index.

   4. Buyback Slowdown — Q2 data already hint at reduced discretionary buybacks post-record Q1; a sharp pullback would expose declining EPS ex-buybacks. 3

   5. Dollar Reversal — A rebound in the DXY would dent translated revenues, shaving 1–1.5 pp off sales growth.

Key Metrics to Track in Remaining Q2 Releases

• • Quality Over Beta: Stick with firms showing real sales and margin expansion rather than EPS engineering.

  • Diversify Beyond Megacap Tech: Leadership concentration leaves portfolios vulnerable if AI enthusiasm cools.

  • Hedge Cheaply: Implied volatility remains low; buying index puts or volatility call spreads offers asymmetric protection per Goldman/Citadel desks.

  • Monitor Buybacks: A slowdown will likely precede a valuation reset; watch Q3 authorizations closely.

  • Stay Data – Dependent: Keep an eye on consumer-spending prints, PMI trends, and Fed language—macro weakness is the catalyst that typically closes the gap between earnings reality and market pricing.

Bottom Line:

Q2 earnings superficially look solid, but the quality of growth is eroding under the weight of record buybacks, currency distortion, and widening macro-market divergence. With valuations already near two-decade highs and liquidity tail-winds fading, the risk-reward skew is increasingly asymmetric. Investors would be prudent to temper expectations, raise select hedges, and focus on genuine fundamental strength as the cycle moves into its late innings.

Have a great weekend, 

— Boaty