Equity Commentary

Investors Shrug Off Uncertainty to Drive Markets Higher

Investors drove equity markets upwards to record high levels in the third quarter in a “risk-on” environment. The third quarter saw a rotation back into growth orientated stocks, and, in particular, the mega-cap technology-based stocks. For the third quarter, the Magnificent 7 group of stocks rose 17.0%, outpacing the S&P 500 which rose 8.1%. This rally has led to an increased concentration of these stocks within the indices. Currently, the top 10 stocks constitute over 40% of the weight in the entire S&P 500, an all-time high. The equal weighted S&P 500 rose only a modest 4.8%, underperforming the headline S&P 500 Index for the quarter.

For the third quarter, Emerging Markets rose 10.1%, outpacing both Foreign Developed markets, (which gained 4.2%), as well as U.S. markets. Equity markets in China gained 20.0% for the third quarter, far outpacing other developed markets such as Japan, which rose 7.2%, and the U.K. markets, which climbed 5.1%.

U.S. small cap stocks outperformed large cap stocks during the third quarter as investors are anticipating a lower interest rate environment and continued sustained economic growth. However, the small cap index currently ranks inferior to the large cap index on a number of quality metrics, including Return on Equity (ROE) and Return on Assets (ROA). Additionally, almost half of the companies in the small cap index do not have positive earnings, while only less than 5% of companies in the large cap index do not have positive earnings.

Inflation Tame Despite Tariff Concerns

Earlier in the year, inflation fears were stoked due to the introduction of proposed tariffs in April. However, recent inflation numbers such as Consumer Price Index (CPI) and Producer Price Index (PPI) have come in relatively tame, and as such, have benefited the outlook for longer duration growth stocks, who benefit from a lower interest rate environment.

A.I. Spending – A Legitimate Trend

High-tech companies continue to allocate capital expenditures to A.I., with an estimated $350 billion to be spent on A.I. in 2025 and an anticipated $402 billion to be spent on A.I. in 2026. Unlike the dot com bubble that eventually burst in the late 1990s, the “A.I. rally” appears legitimate and sustainable, as the companies involved in supplying infrastructure to A.I. architecture are reporting positive earnings and sustained earnings growth, a far cry from companies in the late 1990’s, such as Pets.com, a temporary stock market darling which was ultimately unprofitable and went bankrupt less than a year after going public. Currently, companies such as NVDIA, who supplies microchips related to A.I., have been able to meet lofty earnings goals as well as provide sustainable future earnings growth.

Corporate Earnings – Forecasted Sustained Growth for Q3 More Broad Based

Second quarter earnings results for the S&P 500 came in generally very strong, with year over year earnings growth of 13.8%, led by the Communication Services, Technology, and Financials sectors.

Third quarter earnings are forecasted to see 8.8% year-over-year earnings growth, led by (of course) Technology. However, the Real Estate, Materials, and Industrials sectors are also forecasted to lead third quarter earnings growth, a bit of a change from previous quarters.

Thus far, just over a quarter of companies in the S&P 500 have provided earnings guidance, with negative guidance announcements outpacing positive guidance announcements. It is interesting to note that many other companies have stated they will not currently be providing any quarterly guidance due to increased uncertainty in the marketplace with regards to potential impact of tariffs and other macroeconomic factors.

Calendar year 2025 earnings growth is forecasted to moderate somewhat from last year at 10.8%. Calendar year 2026 earnings growth is forecasted to be 14.1%.

Currently, valuations appear lofty with the S&P 500 trading at 22.9X forward P/E, at the high end of its historic range. With the market rally that occurred during the third quarter, the Price/Earnings Growth ratio (PEG) is also at the high end of its historic range, currently at 2.0X. This comes despite the increased rate of forecasted earnings growth.

Foreign developed markets were outpacing U.S. markets for much of the year, however, during the third quarter, U.S. markets outperformed foreign developed stocks. While the U.S. has seen analysts’ earnings revisions trend upwards, foreign developed markets have seen analysts’ earnings revisions trend downwards, as optimism on sustained earnings growth has become muted outside the U.S. Foreign developed markets are trading at a discount to the U.S. market, with the EAFE forward P/E currently at 16.1X.

We remain cautiously optimistic regarding the potential further upside of U.S. equity markets based upon the quality and sustainability of potential earnings growth. We continue to monitor, and be aware of, analysts’ earnings revisions, as well as macroeconomic and company specific developments and continue to search for opportunities that may provide quality growth at a reasonable price.