Earnings Kick Off With Sky-High Forecasts, Record Stock Market

With stock valuations sitting above long-term norms, investors will also be looking to executives for clues on what the future holds for company profits.

“Do people reward the markets even further from the levels that we’re seeing today?” said Amy Kong, chief investment officer at Barrett Asset Management. “It really depends I think on what management teams would say.”

Investors this week will parse results from big banks like JPMorgan Chase & Co. and Bank of America Corp., as well as from companies ranging from PepsiCo Inc. to

Delta Air Lines Inc.

DAL 2.02%

to

UnitedHealth Group Inc.

UNH 0.53%

The company earnings will offer a glimpse into how businesses are doing more than a year after the pandemic plunged the U.S. into a recession. With questions about the path of inflation and the labor market unresolved, investors have shown signs of skittishness about the market’s course in the coming months.

Analysts project that profits for S&P 500 companies rose 64% in the second quarter from a year earlier, according to FactSet, a growth rate that would be the highest in more than a decade. However, the growth will be measured from a period when much of the economy had been brought to a standstill from the pandemic as consumers retreated and some businesses saw steep declines in revenue. Analysts expect businesses constrained by the pandemic and economic slowdown, like the financial and industrial sectors, to more than double their profits from the same period in 2020.

Also, forecasts have drifted higher in recent months, helped by an unusually large number of companies advising investors that they expect earnings to come in higher than analysts had been estimating.

“The reason for that is simple: The speed and robustness of the recovery is greater today than everyone anticipated three months ago,” said Hal Reynolds, chief investment officer at Los Angeles Capital Management.

It is more common for companies to try to lower expectations as they head into a reporting season.

Federal Reserve officials at the central bank’s June policy meeting suggested they might need to dial back their support for the economy earlier than expected because growth has been so strong.

At the same time, investors in recent days have been considering the threat that labor shortages, supply-chain bottlenecks and the highly contagious Delta variant of the coronavirus might pose to their rosy economic outlooks.

A rally in ultrasafe government bonds pushed the yield on the benchmark 10-year U.S. Treasury note below 1.3% last week, settling Thursday at its lowest level since February. Stocks sold off, with the S&P 500, Dow Jones Industrial Average and tech-heavy Nasdaq Composite on Thursday suffering their worst daily performances in nearly three weeks before bouncing higher Friday.

Investors are weighing each new development with an eye on the hefty price tags that stocks have commanded since the market last year rocketed up from its pandemic lows.

The S&P 500 traded Thursday at nearly 22 times expected earnings over the next 12 months, above a five-year average of a little more than 18.

“Valuations on their own don’t kill a market, but valuations make you vulnerable if there’s an unpleasant surprise,” said Tom Hancock, lead portfolio manager of the GMO Quality Fund.

The economy’s rebound from the pandemic has driven a surge in consumer prices, and investors want to know how higher costs for anything from materials to labor will affect corporations’ bottom lines.

Forecasts call for an S&P 500 net profit margin of 11.8% in the second quarter, above the five-year average of 10.6%, according to FactSet. That recent efficiency in generating profits could be vulnerable as costs rise.

There are signs investors might look harshly on companies struggling to stay fully staffed.

FedEx Corp.

shares fell 3.9% the day after the delivery giant’s June earnings report—and executives said difficulty hiring package handlers had driven wages higher and created inefficiency.

If that experience turns out to be widely shared, it could reshape expectations for the costs that U.S. companies will bear going forward—and potentially the prices their shares are worth.

“I come back to inflation and margins being something that could really create a pause with stocks,” said Larry Cordisco, co-lead portfolio manager of the Osterweis Growth & Income Fund. “Certainly if there’s wage inflation that starts to take hold, I think that is going to get people’s attention.”

Shares of

Darden Restaurants Inc.

meanwhile, rose 3.2% the day after the parent company of Olive Garden topped earnings estimates, even as it pointed to a rise in the costs of food and labor. The company shared a sales forecast that assumes full operating capacity for essentially all restaurants and no significant interruptions related to the pandemic.

Write to Karen Langley at karen.langley@wsj.com