What Happened Last Week
- Rotation Continues: Crowded AI winners continued to lead to the downside as investors rushed into more defensive sectors.
- AI Earnings Disappoint: Reports from Meta and several semiconductor names failed to meet elevated investor expectations.
- Yields Slide: Yields continued to fall from highs, as AI capital spending plans remain the most important near-term driver for bonds.
What We’re Watching This Week
- Earnings Week Three: Microsoft, Google, and Amazon are set to update investors, in what will be a critical test for AI theme sentiment.
- The Fed: The Fed is widely expected to leave interest rates unchanged at its October meeting, and several other central banks are set to convene.
- Economic Data: Beyond earnings and the Fed, investors will also get third-quarter gross domestic product (GDP) estimates and the Fed’s preferred inflation gauge.
Investment Management Team’s Views
Extreme volatility in AI infrastructure stocks and a sharp rotation into the broader equity market made last week feel a lot like July. However, concerns about the durability of AI capital spending are proving harder to shake this time, given elevated interest rates. Strong results from Meta and several AI infrastructure companies weren’t enough to stabilize the trade, suggesting positioning remains crowded and investors increasingly need more than good earnings to add exposure. It is difficult to separate some of the recent nervousness from positioning ahead of the midterms, but the early message from earnings season is that expectations across the AI complex remain exceptionally high. This week should provide substantially more information, with roughly 40% of the S&P 500 Index reporting.
For diversified investors, however, the experience has been considerably less dramatic. Small caps, value stocks, and the average S&P 500 company all advanced last week even as technology remained under pressure. Defensive sectors also benefited from another decline in bond yields, with the 10-year Treasury finishing below 5% after briefly reaching 5.3% less than three weeks ago. More interestingly, fixed income has recently begun trading less on oil headlines and more like technology stocks. To us, that reinforces just how important expectations for AI capital spending have become to the broader growth outlook. If that spending is the marginal driver of stronger growth expectations, technology earnings may matter more for the near-term direction of long-term yields than this week’s Fed meeting.
That makes this one of the season’s most consequential earnings weeks. The Fed announces its decision Wednesday afternoon, followed just hours later by Microsoft and Alphabet, with Amazon reporting Thursday. Investors will be focused not simply on whether AI spending continues to rise, but on cloud demand, revenue growth, margins, cash generation, and evidence that increasingly large capital commitments are producing adequate returns. Thursday also brings the first estimate of third-quarter GDP and September inflation, giving markets another important read on the underlying economy. With popular positioning already under pressure, strong fundamental evidence from the hyperscalers could help stabilize the AI trade, while another round of good results met with selling would suggest the reset still has further to run.