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Possible Bad News & Good Buying Opportunities Ahead
When we lowered S&P 500 year-end target a month ago, it had nothing to do with the market’s fundamental underpinnings. Our concerns remain valuation related in light of rising uncertainties in the investment backdrop. But don’t be tricked by scary surprises that send stocks southward; they could be attractive buying opportunities, say Ed and Elias, given the robust economic growth and corporate earnings we continue to expect. Today, they explain why prospective frights from four directions—geopolitical, US political, the Fed, and AI—could turn out to be opportunities in disguise.
US SECTORS CALL: Communication Services, Materials & Energy
Investors spent the week worrying about an AI bubble. The S&P 500 slipped by 0.5%, led by a 6.2% drop in Communication Services (MW), which was the worst-performing S&P 500 sector (table). Yet, Information Technology fell just 0.3%. Energy (OW) led the winning sectors with a 1.6% gain, followed by Health Care (OW), up 1.5%. Bubbles inflate valuation multiples. This year, multiples have contracted. The S&P 500's forward P/E has fallen to 18.6 from 22.2 at the end of 2025 (chart). Information Technology's forward P/E is down to 19.0 from 26.5. Stocks have gotten cheaper this year as earnings growth outpaced stock price gains. Here's more on the Communication Services, Materials, and Energy sectors: (1) Communication Services. Meta's Q3 report last Wednesday hit the sector hard. Its free cash flow turned negative for the first time since its 2012 IPO, and it raised its 2026 capex guidance floor to $135 billion. Its shares fell 7.0% and Interactive Media & Services fell 4.3% on Thursday, closing down 7.0% for the week. Alphabet and Meta dominate the sector. Together they account for 81.8% of its market cap and 70.0% of its forward earnings (chart). The sector's forward earnings is up 23.9% ytd, while its stock price index is down 2.3% (chart). Its forward P/E has dropped to 17.2 from 22.1 at the start of the year. That puts it below the S&P 500's 18.6. Analysts expect earnings at Interactive Media & Services, the sector's largest industry, to rise 72.3% this year, then fall 17.6% in 2027 (chart). Yet they expect its revenues to grow 25.0% and 22.8% over the same two years. Unrealized gains on Alphabet's stakes in private AI companies, including Anthropic, inflated this year's earnings. The de-rating isn't limited to AI. Netflix, which accounts for more than half of Movies & Entertainment's market cap, reported Q3 results on Tuesday. It cut its ad revenue outlook and guided Q4 earnings below expectations. Its stock is now down 51% from its mid-2025 record high. (2) Materials. Materials slipped 0.1% this week. Gold and Copper were the sector's worst-performing industries, down 8.2% and 6.3% (chart). Copper stocks fell along with the AI trade on Thursday. Copper futures also fell slightly last week, ending at $6.48 per pound. The AI selloff hit industrial metals on Thursday, but copper rebounded on Friday. Rising inventories also weighed on the red metal last week. Copper flowed back into London Metal Exchange warehouses, where inventories rose to their highest since July. Traders spent the year shipping copper to the US ahead of potential tariffs. The US price premium that drove those flows has turned into a discount. Copper remains near the top of an uptrend channel that began in 2016 (chart). Forecasts have copper earnings rising 76.3% this year and 41.2% in 2027. The forward profit margin is up to 17.1%, the highest since 2022, yet the forward P/E has dropped to 16.4. The selloff hit stock prices, not earnings estimates. Analysts expect Materials earnings to rise 40.2% this year and 11.8% in 2027. Materials accounts for just 1.9% of S&P 500 forward earnings and only 1.6% of its market cap, the smallest share in over 30 years (chart). We remain overweight. Materials offers rising earnings at a shrinking multiple. (3) Energy. Energy is up 55.1% ytd, the best-performing sector. Its forward earnings has risen even faster, up 76.5% ytd to a record high (chart). Energy still has the lowest forward P/E of the 11 sectors, at 13.8, down from 15.7 at the start of the year. Analysts see 2026 as the peak. They expect sector earnings to rise 101.9% this year, then fall 8.0% in 2027. Refining & Marketing shows this most clearly. Its forward profit margin has soared to a record 9.0% (chart). Its forward P/E is 9.0, with earnings forecast to fall 11.0% in 2027. Oil & Gas Equipment & Services is the exception. Analysts expect its earnings to fall 9.7% this year, then rise 25.2% in 2027 and 18.9% in 2028 (chart). Consensus estimates assume the oil premium fades, and we expect it will eventually. Renewed strikes on Iran after the midterms, which the US and Israel reportedly have planned, would challenge the fading-premium assumption. At only 3.7% of the S&P 500's market cap and a forward P/E of 13.8, Energy is a cheap hedge against more geopolitical turmoil.
GLOBAL MARKETS CALL: Bond Yields Ease
Bond yields eased in most major markets last week, but France was the glaring exception. In stocks, the global AI selloff kept hitting the equities markets that had gained the most this year, putting the US back ahead of the All Country World ex-US ytd. That supports our downgrade last week of Go Global to market weight, though the fundamental case for overseas stocks remains strong. Here's more: I. Global Bonds Yields fell in five of the eight major bond markets we track (chart). The US 10-year Treasury yield fell to 5.00%. France's yield jumped 24bps to 5.02%, slightly surpassing the US’s. Yields also fell in the UK, Australia, Germany, and Japan. The spread between French and German 10-year yields widened 31bps last week to 167.9bps (chart). Last week, we wrote that contagion from France had eased for now. It’s back. Italy’s spread widened to 123.9bps from 106.6bps. Greece’s widened to 105.0bps from 90.8bps. Italy’s 10-year bond now yields 44bps less than France’s. II. Global Stocks Brazil remains at the top of the country ETF rankings mtd, up 14.3% in dollars (chart). South Korea remains at the bottom, down 17.2%. The US is down just 0.3%, while the All Country World ex-US ETF is down 2.8%. Go Global no longer leads Stay Home this year. The US ETF is up 11.4% ytd, ahead of the All Country World ex-US ETF's 9.5% (chart). Taiwan (65.1%) and South Korea (55.6%) still top the ytd rankings, followed by Brazil (34.1%). China (-15.6%) and Indonesia (-43.3%) are at the bottom. III. Global Earnings & Valuations The US MSCI's share of the All Country World MSCI's market cap has edged up to 65.0% (chart). The Emerging Markets (EM) MSCI’s share slipped to 11.7% from 12.1% last week. Yet the EM MSCI now accounts for 20.2% of the All Country World MSCI’s forward earnings (chart). That’s more than Europe’s 15.0%. It’s the first time that EM has overtaken Europe since the data began in 1995. The US accounts for 54.4% of forward earnings, well below its market-cap share. That mismatch shows up in valuations. The US MSCI’s forward P/E is 19.2 versus 12.2 for the All Country World ex-US (chart). The ex-US multiple has dropped from 15.7 in January even as its forward earnings soared. The EM MSCI trades at just 9.0. IV. In Focus (1) Brazil. Brazil’s MSCI stock price index is up 22.2% ytd in local currency and 31.0% in dollars (chart). The real has gained 8.0% against the dollar this year. In dollar terms, the index remains less than half its 2008 peak. Stocks rallied after Senator Flávio Bolsonaro took a surprise lead in the October 4 first round. He held a narrow edge in the final polls before the October 25 runoff against President Luiz Inácio Lula da Silva. A Bloomberg poll released on October 19 gave Bolsonaro 51.1% of valid votes against 48.9% for Lula. Valuations aren’t stretched. Brazil’s forward P/E is 9.2 (chart). That’s below its 2025 high of 10.7. The catch is that analysts expect earnings to grow 44.6% this year but just 0.6% in 2027. Brazil’s central bank has room to ease. It has lowered the Selic rate to 13.75% from a peak of 15.00% (chart). Inflation was 4.6% in September. That leaves a real policy rate of about 9%. (2) China. China’s property bust is deepening. The Shenzhen Real Estate Stock Price Index fell to 953.55, breaking below the floor that had held since 2012 (chart). Last week, we wrote that we would worry if it did that. Now we are worried. Real estate investment is down 20.6% through the first nine months of the year. Exports continue to carry the economy. Beijing’s stabilization efforts haven’t stopped the selling. The China ETF (FXI) fell 4.5% last week. Chinese technology stocks have missed the AI rally that lifted US tech (chart). The China Technology ETF (CQQQ) is at 40.26, far below its 2021 peak. China’s bond market confirms the deflationary picture. The 10-year government bond yield is down to 1.62% (chart). It’s one of only two major yields that have fallen this year. China’s yield is now well below Japan’s 2.80%.
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