I’m bullish on stocks going into the fourth quarter. Earnings growth is still strong, spending on AI is ongoing, and I think we’re heading into another strong earnings season.
There’s a lot of concern about the dollar and Treasury yields right now, and I understand why. Both have been moving higher, which makes financial conditions more difficult. But I think you have to look at the companies that are growing their earnings regardless of those conditions. That’s a big part of why I’m still constructive on the market.
Look at the earnings
FactSet is expecting S&P 500 companies to report 29.5% earnings growth for the third quarter compared with the same period last year. Those are expectations, so we still have to see what the companies actually report. But that’s a strong starting point.
Keep in mind, the stock market being at a higher price doesn’t necessarily mean you’re paying more for the businesses.
At the start of October last year, the S&P 500 was trading at 22.8 times expected earnings. At the start of this October, that number was 19. So you’re paying less for each dollar of expected corporate earnings than you were a year ago.
That can seem strange if you’re only looking at the chart. The market is higher, but the multiple is lower. Expected earnings have grown faster than the price. That’s a healthy trend from a fundamental point of view.
Of course, those earnings still have to come through. If this is a poor quarter, I’ll have to change my view. I just don’t think that’s the most likely outcome based on what I’m seeing going into it.
A lot of this comes back to AI. The large cloud companies are spending heavily, and that spending is turning into revenue for the businesses supplying the infrastructure. In its September report, a16z estimated that its broader technology group accounted for roughly 76% of the S&P 500’s projected earnings growth this year.
AI needs power. It needs chips. It needs memory. And all of those things have to work together.
You can build the data centres and buy the equipment, but those investments don’t come to fruition without enough electricity to run them. That’s why the spending extends into the power grid, cooling and the rest of the infrastructure. It’s a much bigger trend than just the companies building the models.
I think we’re still years away from seeing the full effect of this technology on how businesses operate. But the companies supplying it are already earning money from the build-out. That’s what keeps me interested. I want to understand what the technology needs, where the demand is going and whether that’s showing up in the numbers.
I want to see the rest of the market catch up
I don’t think it’s a particularly healthy market if technology keeps moving higher while everything else goes nowhere. Tech can lead, but I’d like to see buying spread into more companies and more parts of the market. If that doesn’t happen, my view becomes a little more cautious.
I also think there’s still a lot of pessimism out there. If companies report strong earnings and the market responds well, some of the investors who’ve been sitting back will start to feel that they’re missing out. The same goes for managers who are behind their benchmark. That can bring more buying into the market as people try to catch up.
We’ll see how it plays out. I don’t need to know exactly which day that happens to have a view on the quarter.
This is where patience becomes difficult, especially if you’ve done well in business.
In your business or your career, you can make things happen. You can put more work into something and influence the outcome. In the markets, you can’t make anything happen. You can buy, you can sell, and there’s a third option that’s easy to forget: doing nothing.
Sometimes you just have to wait. That’s easier when you understand why you have a view and what would tell you it’s wrong. If the earnings change, or the business changes, that matters. If the price moves around for a few weeks while the underlying picture stays strong, I don’t think that automatically calls for a different view.
I’m not trying to make perfect predictions. I’m trying to make decisions where more of the odds stack in my favour than against me. Going into Q4, I think the earnings picture supports a positive view on equities. Now I want to see the companies deliver.
