A Choppy Market Ahead, but Earnings Provide Support

By Terry Gardner

October was a volatile month for both stocks and bonds. The NASDAQ fell more than 2.6%, and the 10-year Treasury yield closed below 5% for the first time in a while. We’re now well into the fourth quarter and digesting third-quarter earnings releases, which have been particularly strong. We also recently sent out our quarterly client letter, and I want to share some thoughts from that note here.

The AI Debate Has Moved Through Several Phases

The dominant theme in the market remains the pace of the AI infrastructure build-out. In my view, the market’s acceptance of that spending has gone through several distinct phases.

Phase one: the ChatGPT launch. OpenAI’s ChatGPT kicked off a wave of excitement around AI spending. The hyperscalers and other large companies with the balance sheets to fund the build-out were the early winners, and their stocks responded well.

Phase two: the DeepSeek moment. An open-source model out of China threatened that leadership. Those stocks sold off, and the market entered a period of digestion and questioning about where all of this was headed.

Phase three: the “SaaS-pocalypse.” After most of the AI leaders recovered, attention turned to which companies AI would disrupt. Software as a service was right in the middle, along with some IT services and data services names. Those stocks sold off meaningfully and have only partially come back.

Phase four: return on invested capital. Each time the hyperscalers raised their capital expenditure forecasts, investors asked when all that spending would start paying off, and the stocks came under pressure. We worked through that phase as companies began showing returns, enterprise adoption broadened, and consumer AI agents like Meta’s Muse launched.

Phase five: how the build-out gets funded. Where we are today. The market is now scrutinizing companies that aren’t only spending free cash flow on AI infrastructure but are also looking to issue new equity and debt to pay for it.

Meta’s Results and the New Question of Capital

Meta’s third-quarter report last night shows the shift. Results across its core business were excellent. Not many businesses of that size can grow revenue north of 25%, and Meta did, which is remarkable. But investors focused on something else. Meta is creating a new class of shares that could be used to raise capital for its AI build, and capital spending is likely to step up another notch and stay elevated for the next couple of years.

That set off questions today about whether the build-out is sustainable, over what time frame, and whether there’s enough capital available to keep it going. Capital availability is now the debate. It’s playing out alongside political pushback on data centers, a tightening Fed, higher-than-normal inflation, rising energy costs, geopolitical tensions, and midterm elections that could change the direction of national policy. All of that came together to push the market down meaningfully today.

What Could Signal a Turning Point

So when does this get resolved? We’d all like to know, but we probably won’t for a long time. I’d expect choppy waters until we get more clarity on the AI infrastructure debate.

The turning point, I think, will come when we first see an AI power user pull ahead of its competition because of how it puts AI to work. That would validate the investment thesis. Investors would see a real return on invested capital and a competitive advantage that comes with it, and more companies would follow.

A story on the newswire today about Uber shows how early we still are. Uber is a technology-savvy company that employs a lot of engineers, and it was an early adopter of AI models. It was one of the “token maxing” companies that spent heavily on tokens to get as much out of AI as it could. Yet Uber only announced today that it’s rolling out ChatGPT Work to all 30,000 of its employees.

If a leader in AI adoption is only now deploying an enterprise version of ChatGPT, enterprise adoption has a long way to go. I think we’re moving toward increased usage of AI that will keep driving demand for compute and inference, and the underlying business still looks relatively healthy.

Is AI a Bubble?

The other debate in the market is whether AI is a bubble. A bubble forms when supply grows faster than demand for a product or service, and we’ve seen several over the last 30 years:

• The fiber bubble of the late 1990s, when more fiber was laid than there was demand for over the following several years
• The real estate bubble of 2006–2007, which led to the Great Financial Crisis of 2008–2010
• The oil and gas oversupply from the fracking boom, which collapsed domestic oil prices between 2014 and 2016

Not every predicted bubble materializes, though. After the iPhone launched in 2007, some investors expected smartphones to reach saturation and become a mature business. That clearly didn’t happen, as Apple kept innovating and generating new replacement cycles. We could see something similar with AI infrastructure, where equipment becomes outdated, gets replaced, and keeps spending on new technology high.

The bigger question is this: what is the equilibrium for intelligence? At what point does the supply of intelligence outstrip the demand for it? It’s a big question to ponder.

Third-Quarter Earnings Are Coming in Strong

Now for more mundane matters. If you’ve followed our work at C.J. Lawrence over the years, you know we place a lot of emphasis on earnings. Sentiment and market narratives can be volatile, but ultimately stock prices reflect the earnings power of the underlying companies.

Third-quarter results are coming in very strong. Just a few weeks ago, the estimate called for 28.6% year-over-year earnings growth for the quarter. Results are coming in around 38%. Looking ahead, estimates for 2027 and 2028 also point to robust growth.

Looking Past Concentration: The Equal Weight View

Some will argue that a handful of big names are driving those numbers. To get past the concentration debate, I like to look at the S&P 500 Equal Weight Index. It doesn’t exclude the largest companies, which are important. It simply gives them the same weighting as every other name.

Expected earnings growth for 2026:

• S&P 500: 34%
• S&P 500 Equal Weight Index: 21%

For the Equal Weight Index, forecasts call for 10.3% growth in 2027 and 11.6% in 2028.

We used to consider double-digit earnings growth substantial and supportive of stock prices. We’ve since gotten used to growth in the 20s and even 30s, so the equal-weight numbers may look modest by comparison. On a historical basis, they’re strong. The Equal Weight Index has averaged 9.75% earnings growth over the last 15 years, and the estimates for this year and the next two years all exceed that.

Valuations Look Reasonable

What are we paying for those earnings? Forward price-to-earnings multiples for the Equal Weight Index:

Those are pedestrian multiples on earnings that I think are quite strong. A fair pushback is that higher interest rates and higher inflation justify lower multiples than we’ve seen in the past, and AI adds a layer of uncertainty to future expectations. I agree, and lower multiples on attractive earnings make sense in that environment.

But put it in perspective. During the rapid rate increases of 2022, the Fed raised the fed funds target rate from 0.25% to 5.5% in about 18 months. The market multiple fell from 21 to about 16 before settling around 18. Today’s multiples are lower than that, and we’ve seen only one 25 basis point increase. We likely won’t get another at the next Fed meeting, though one could follow after that. Any further increases look far more gradual than what we saw in 2022.

Choppy Waters, Reasonable Prices

I expect volatility to stick around, with choppy trading as the narrative and sentiment swing back and forth. Earnings should continue to be solid, which gives me some comfort and provides real support for the market. It may be hard to justify higher multiples from here given the uncertainty AI brings, but I think these stocks are reasonably priced and can be bought here.

If you have any questions, I’d love to hear from you. Call me at 212-888-6403 or email terry.gardner@apollonwealth.com.