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On Bubblish AI, Fiscally Feckless France & Weaker Earnings Estimate Revisions
If AI is a bubble, how vulnerable are investors? Can it even be considered a bubble, detached from fundamentals, with demand for compute growing like gangbusters? Demand so strong doesn’t mean highly leveraged players can’t be at risk, and their investors exposed, if returns take longer than expected to materialize or fall short of infrastructure build-out costs. Melissa doesn’t think valuations have detached from fundamentals, but she does see them becoming increasingly “bubblish.” … Also: William discusses how France’s ailing government bond market has weakened the euro—the last thing the ECB wanted. … And: Joe shares takeaways from his NERI index tracking the direction of analysts’ estimate changes for S&P 500 companies.
Is FEMO Too Concentrated?
I. Stocks: Happy Fourth Anniversary! Yesterday marked the fourth anniversary of the stock market bull run. The S&P 500 is up 118.3% since it began. The bull market has survived the pandemic, global supply-chain disruptions, rebounding inflation, two oil price shocks, a significant round of Fed rate hikes, soaring bond yields, a financial crisis, Trump's tariffs, and two wars. It has also survived concerns about the market’s leadership being too concentrated in a few outperforming stocks. Only two of the S&P 500's 11 sectors have outperformed the index: Information Technology (258.1%) and Communication Services (196.7%). The others posted reasonably strong bull-market returns. Keep in mind that the three most underperforming sectors include many companies that pay relatively high dividends to shareholders (charts). Since 2025, the current bull market has been increasingly led by FEMO (Fabulous Earnings Momentum). Since the bull market started, S&P 500 forward earnings is up 73.9%, while the forward P/E is up 25.4% (chart). A recent concern is that FEMO has been too concentrated. Our diffusion indexes show that the percentages of S&P 500 companies with positive 3-month and 12-month increases in forward revenues and forward earnings have risen significantly during the bull market (charts). On a y/y basis, all sectors are showing solid gains in forward earnings, with the three worst laggards including many companies that pay relatively high dividends to shareholders, as noted above (chart). Nevertheless, this has been a tough year for stock pickers so far, with 41.2% of S&P 500 companies’ stocks down ytd (chart). II. Update on the US Economy As we noted recently, analysts expect positive revenue and earnings growth across all 11 S&P 500 sectors in Q3 on a y/y basis. This broad-based strength reflects the remarkable resilience of the US economy. The latest economic indicators provide further evidence of that resilience. Here's more: (1) Bank earnings. The big banks kicked off Q3 earnings season today, with JPMorgan Chase, Goldman Sachs, Citigroup, and Wells Fargo reporting solid results. Their commentary confirms that strong consumer spending and business investment are translating to robust lending growth and investment banking activity, while credit quality remains healthy (chart). JPMorgan CEO Jamie Dimon pointed to "strong business investment and ongoing consumer spending," while Goldman Sachs CEO David Solomon observed that "the economy continues to be very, very resilient despite some of the headwinds." Wells Fargo CEO Charlie Scharf offered a particularly upbeat assessment, noting that despite mixed consumer sentiment, "consumers are spending more, loan delinquencies are low, and deposit and investment balances have grown." He added that strong employment, wage growth, and AI infrastructure investment continue to outweigh the risks from higher interest rates, oil prices, and inflation. Citigroup CEO Jane Fraser likewise observed that despite all the attention surrounding the AI boom, "the consumer is still driving much of the growth." (2) Consumer spending. The latest Redbook data confirm the bank CEOs’ upbeat assessments of the US consumer. Redbook same-store sales surged 10.4% y/y during the week of October 9, the strongest increase since 2022 (chart). Bank of America's September Consumer Checkpoint provides further evidence of consumer strength. Credit and debit card spending per household rose 6.2% y/y, or 5.1% excluding gasoline, both the third-fastest rates in four years! Even more encouraging, spending growth is broadening across income groups. Card spending rose 5.5% y/y among lower-income households, compared with 4.9% and 4.8% among middle- and higher-income households, respectively. Only the top 5% of earners posted stronger growth, at 5.9%. (3) Labor market. What's behind the broadening of consumer spending? A key pillar is the labor market. Bank of America also reports that after-tax wage and salary growth reached 4.5% y/y among lower-income households in September, compared with 3.8% and 3.7% among middle- and higher-income households, respectively. Stronger wage growth is helping consumers absorb higher living costs without sacrificing discretionary spending. The latest weekly ADP data suggest that labor market strength persists. Private-sector employment rose by 24,750 during the week of September 26, the sixth consecutive weekly acceleration and the strongest gain since early June (chart). That implies a monthly pace of roughly 96,300 jobs, comfortably above most estimates of the breakeven pace needed to keep the unemployment rate low and stable. Meanwhile, small business hiring plans moderated somewhat in September but remained above historical norms. The latest NFIB survey showed that 17% of small businesses planned to increase employment, well above the historical average of 11% (chart). Job openings remained 8 percentage points above their historical average. A shortage of qualified workers continues to constrain hiring, with 45% of firms reporting no qualified applicants for their open positions compared with the historical average of 37%. The bad news is that the NFIB survey shows that pricing pressures remained elevated in September (chart). The most frequently cited problem faced by small business owners is the quality of labor (chart). We expect they will solve this problem by boosting productivity through AI and other technologies.
On China’s Banking Crisis & New Trade Flexibility
In consolidating its banking system, William reports, China risks repeating the mistakes Japan made in the 1990s when bad loans simply migrated to new balance sheets instead of being recapitalized. That paved the way to years of deflation and near-zero interest rates. … Also: Uncharacteristically, China has agreed to EU demands to halve its hybrid vehicle shipments to Europe, deescalating tensions between the two and perhaps opening the door to similar deals for other industries. What does China’s new conciliatory tack imply for its trade negotiations with other economies? Does the deal represent a new model for global trade?
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