Market Extra: Stock market bulls are counting on solid quarterly earnings

The U.S. stock market greeted the start of the earnings season with continued optimism. All three main benchmarks reached record levels as the first batch of companies reported quarterly results.

Large banks that officially kicked off the earnings season in the past week showed solid profits, setting the tone for the rest of the season. The performance of financials over the week was lackluster, however, as shares of large banks declined.

Citigroup Inc.

C, -0.36%

 shares lost 4.7%, while Wells Fargo & Co

WFC, -2.75%

 dropped 3.4% over the week.

Over the next two weeks more than 200 companies are expected to report their quarterly results.

Read: 4 things that might surprise investors this earnings season

According to FactSet, by Thursday 6% of the S&P 500

SPX, +0.09%

 companies reported earnings, and about 80% of these beat expectations on revenues and profit. Analysts polled by FactSet expect 2.8% earnings growth for the S&P 500 in the third quarter, and if companies exceed expectation at the usual rate of about 3 percentage points, it is fair to anticipate mid-single-digit profit growth.

Among the companies that already reported, about half blamed recent hurricanes for poor third-quarter earnings or warned they would to have a negative impact on earnings and revenues in future quarters.

Markets, meanwhile, climbed to records last week.

Valuations are lofty, suggesting to some analysts that investors might have already fully priced in solid earnings growth.

Currently, investors are paying 18 times 12-month forward earnings per share—well above the average levels of multiples.

The cyclically-adjusted price-to-earnings, or CAPE, ratio, designed by Nobel laureate Robert Shiller paints ean ven more alarming picture. CAPE is at 31 is higher than it was in 1929, just before the market crash. Multiples, however, are seen as poor guides to market timing. After all, during the tech bubble in 2000, CAPE climbed to 44.

Some analysts suggested that this market is approaching a melt-up environment, when investors pile into stocks out of fear of missing out of the rally, pushing valuations even higher.

“This market can be described as a push and pull between momentum and valuations and momentum is winning out,” said Wouter Sturkenboom, senior investment strategist at Russell Investments.

“But valuations are really stretched at this point, and this overhang creates a risk for potential a downturn,” Sturkenboom said, adding that no model can accurately signal the top of the market.

The fact that stocks are fully pricing in double-digit earnings growth for the year, there is a potential for disappointment, according to Sturkenboom.

While the absolute levels of the S&P 500 and Nasdaq Composite

COMP, +0.22%

 are impressive the journey there has been so incremental that few people are calling it euphoric yet.

For example, the S&P 500 is up 14% year to date at 2,553.17, after rising eight months over the past nine. The year so far has been marked as one of the least volatile. There have been eight days in 2017 when the index moved more than 1% and zero days when it moved by 2% or more.

The implied volatility on the S&P 500, as measured by the CBOE Volatility Index

VIX, -3.03%

 has been trading below 10, near the lowest levels in more than a two decades.

Read: Low stock volatility won’t last forever, but the quiet may not end quickly

Over the next few weeks, investors will continue to focus on earnings releases, but political and geopolitical news are worth paying attention to, according Sturkenboom.

Domestically, investors will continue to follow the tax debate and what impact, if any it will have on corporate profits.

Investors have also paid little heed to a potential change in leadership at the Federal Reserve. Janet Yellen’s term as a chairwoman ends in February.

On Friday, outgoing Vice Chairman Stanley Fisher called on President Trump to renominate Janet Yellen.

See: Trump’s pick to lead the Federal Reserve is (probably) on this list

Among possible candidates is former Fed Gov. Kevin Warsh, Fed Gov. Jerome Powell and Gary Cohn, top White House economic adviser. Trump met with Stanford University economist John Taylor on Wednesday, who is also being considered for the job.

Also see: Stock market in wait-and-see mode as Trump mulls Fed chair nominee