The AI Earnings Engine: Is It Strong Enough to Justify Record Highs?

Despite continued debate over tariffs, Fed cuts and the exuberance of the Artificial Intelligence theme, equity market indices have returned solid gains for the year with growth sectors continue to deliver outperformance.

At the 90% mark of S&P 500 companies earnings reports, US equities delivered an earnings per share growth of 12% with a beat of around 7%. This is the fourth consecutive quarter of US companies delivering double digit earnings growth. Euro Stoxx 600 listed equities show an average earnings growth rate of 2.6%, also beating expectations. Financials and technology companies are the largest contributors to earnings growth, consistently across both regions. At sector level, earnings declines were largest in the communications sector in the US, and the consumer discretionary sector in Europe. With a lot of the positivity already captured in the year-to-date equity market rally, the market has punished missed earnings expectations more than rewarded earnings beats.

The earnings reports of the magnificent seven marked a decisive week for investors. Despite the high bar and strong year to date performance, the earnings results reaffirmed the strong momentum, driven by massive AI infrastructure investments and efficiency. Highlights to note include Microsoft and Alphabet’s beat on expectations, with the latter’s cloud margins increasing to 23.7%. Nvidia signalled robust demand visibility, ahead of its earnings release, announcing 14M more Blackwell and Rubin GPUs over the next five quarters. Amazon’s results also buoyed by better-than-expected retail results and reaccelerating revenue growth in its cloud business. All fundamentally supportive of the AI trade. 

The magnitude of capital investment announced to fund AI growth, however, was the key highlight of the quarter. This has shifted investors to question the sustainability of the extraordinary spending on AI and the means to justify it. For some, such as Meta, this meant that guidance came in below expectations. Meanwhile, Microsoft blamed its supply constraints for lower-than-expected guidance. This is despite that their AI capacity will be 80% higher at year end compared to the start of the year.  

Beyond the Artificial Intelligence theme, economic fundamentals are likely to support sector broadening, as earnings per share grows across more sectors. Softer CPI and labour market weakness is underpinning expectations for the US Federal Reserve’s to cut interest rates. Essentially setting up more favourable financial conditions to generate economic growth.

While leading economic indicators in Europe already show strength into the fourth quarter. The Purchasing Manager Indices Composite stood at 52.2 despite France fragile domestic political backdrop. This marked an expanding economy driven by the services industry, following a total of 1% interest rate cuts by the European Central Bank that is supportive for economic growth in the region. The strength of the euro is likely to be a lesser headwind for European exporters, that have lagged the market over the recent months.

Together with the resilience shown in the current earnings season, this backdrop gives us confidence that the fundamentals remain supportive for global equity markets in the coming months.

Rachel Meilak is a portfolio manager at BOV Asset Management Ltd.

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