In a surprising turn of events, strong earnings beats from Corporate America may no longer be sufficient to sustain the ongoing stock rally. As more than 400 firms in the S&P 500 Index have reported earnings this season, a staggering 79% of them have surpassed profit expectations. However, the market's reaction has been rather muted, with the median stock outperforming the index by a mere 0.1% on results day - the smallest margin seen since late 2020.

Traders' skepticism regarding companies' ability to deliver in the future is the driving force behind this subdued response. Weaker-than-expected guidance has led to stocks being punished, as only 15% of S&P 500 companies provided an outlook that exceeded estimates through April, marking the second-lowest reading since the pandemic struck, according to Bloomberg Intelligence data. Although there has been a slight uptick in the latest week, with companies like Apple Inc. forecasting better-than-expected numbers, the percentage still remains comparatively low at 18%.

The S&P 500's remarkable 20% rally since the end of October through April has caused the equity gauge to trade at 20 times projected profits, which is 11% above its 10-year average. Consequently, traders are eagerly searching for reasons to justify these high valuations and are increasingly focused on future growth prospects.

Keith Buchanan, senior portfolio manager at GLOBALT Investments, emphasizes the critical importance of guidance this earnings season due to the high valuations involved. He stresses that there is a substantive level of optimism priced into the market, and any disappointments could lead to considerable downside risk.

In light of the US economy's decline to an almost two-year low in the last quarter, coupled with lingering inflationary pressures and uncertainty surrounding interest rate cuts, expectations for corporate earnings growth have been considerably heightened. As Quincy Krosby, chief global strategist at LPL Financial suggests, in the absence of rate cuts, guidance becomes a crucial factor in justifying market valuations.

Bloomberg Intelligence data indicates that chipmakers across the S&P 500 are expected to witness a roughly 40% growth rate in the second quarter, making them the strongest performers among all industry groups. Nevertheless, this hasn't been sufficient to maintain the Nasdaq 100 Index above its pre-earnings season level, as major chipmakers issue warnings about future profits. Intel Corp. shares tumbled after providing a weaker-than-anticipated second-quarter outlook, while Advanced Micro Devices Inc. shares also fell following a disappointing forecast for its artificial intelligence processors.

While results from consumer bellwethers are still a few weeks away, recent restaurant earnings reports from McDonald's Corp. and Darden Restaurants Inc. have raised incrementally cautious commentary on low-end consumers. Both companies highlighted declines in visits from this category. Starbucks Corp. reported a decline in sales for the first time since 2020, with transactions falling in every region. The company also revised its full-year revenue growth forecast to low single-digits.

Investors are now awaiting forecasts from major US retailers such as Walmart Inc. and Target Corp., as they release their results later this month. Additionally, the latest read on consumer sentiment next week will provide further insights into the market's direction.

Matt Maley, chief market strategist at Miller Tabak + Co., believes that between now and the end of the summer, either a significant improvement in guidance or a decrease in interest rates needs to occur. Otherwise, the S&P 500 might experience another leg lower and potentially a full correction.

As traders continue to closely monitor profit outlooks and guidance, the fate of the stock rally remains uncertain. The market's reaction to earnings reports and the level of optimism for future growth will undoubtedly shape the trajectory of the stock market in the coming months.