AI Volatility Lowers Earnings Bar, Adds Pressure on Mag 7 CapEx

Sam (0:00)

Welcome back to Morning Trade Live. It's time now for the big picture. So let's welcome in the team from Charles Schwab, Center for Financial Research, Liz Ann Saunders, Chief Investment Strategist and Michelle Gibley, Director of International Equity Research and Strategy. Good morning to both of you ladies. Thank you so much for your time and really setting up the week here. I mean, Liz Ann, we've just heard about another person sort of coming out and defending CoreWeave off the back of Intrader, Jensen Huang and Dan Ives. I mean, given what we saw in terms of that semi-trade last week, do you think that resets the bar for earnings? Like, has the bar now for some positive upside post earnings report being lowered since, say, the beginning of October?

Liz Ann Sonders (0:43)

Yeah, and I think Oldman's upgrade of CoreWeave is important because it had become a bit of a bellwether in terms of the concerns that have been brewing about AI and the longevity of the CapEx cycle and how far we can extrapolate what have been really strong earnings. So I think that that was a piece of it. But I also think that this correction that we've gotten, certainly in the semis, tech down between October 6th and October 16th, Friday's close, that's seven and a half percent. I think it sort of reset expectations, maybe lowered the bar a little bit in terms of some of those really pie in the sky assumptions out there. But it does now require that the E actually come to fruition. And so that's the state, I think. I think we've seen enough valuation compression, but now all eyes are on whether there is that sustainability of the denominator in the equation. I think that's the most important thing to look at during third quarter reporting season, as well as stability and strength and profit margins and how far we can assume those will persist.

Sam (1:47)

Okay, and just getting out to you, Michelle, I mean, ugly scenes out of France over the weekend. I was just speaking to Peter Scheer about that and the potential for the contagion risk here in the US. But how are you watching this story? Because the bond market seems to want the government to spend less, but citizens are out in the street wanting the government to spend more. So what do they do and what do markets do?

Michelle Gibley (2:07)

Yeah, I mean, the problem is government spending is too high.

And this has been the case for a while, and the bond market there has been telling us that. You know, the debt trajectory there on is just really unsustainable. You have debt to GDP now surpassing 100 percent.

French's 10-year interest rate is above its 10-year average nominal growth. And the fiscal deficit is expected to be almost 5.5 percent this year. So we really need either higher taxes or spending cuts. Right now, they're trying to get the 2027 budget through. That's the immediate concern for markets where the government may need to use Article 49.3 to bypass a parliamentary vote just to get it passed. And then you have some uncertainty about what happens next under a new government. You know, elections are not for another six months, and France's bond market could remain a source of volatility. There's been a little bit of a spolover into other eurozone bond markets, but it's not just orderly or to the point where the ECB would step in to buy bonds. Now, the ECB would likely use that transmission protection instrument, the TPI, to target non-French bonds first, because they don't want to step in before the election. They really want to see some fiscal discipline. But this uncertainty could continue to hinder European stocks.

Sam (3:32)

Yeah, and it's interesting because the ECB at the moment there had been seen as one of the more sort of hawkish central banks and now obviously there's an expectation going into the end of the month that they could be sitting on their hands. Getting back to you, Liz Ann, I mean, given some of the fears that we were just discussing within the AI trade, do you believe that these concerns could dog these shares for a while or do you think the earnings can offset that? I mean, what would we need to hear as far as some of these CapEx commitments?

Liz Ann Sonders (4:02)

I think we need to see a reinforcement of the consensus estimates that are out there, which would be a trillion this year and moving up higher next year. I think the other thing that really matters in terms of understanding market reaction and individual stock reaction, and Sam, we've talked about it on this program before, you have the published sell-side consensus estimate. We can easily track that. That's the math done every day as reports come in, and what's the beat rate and what's the percent by which companies are beating, but that's against the published sell-side estimate. There's also maybe a loftier buy-side estimate that isn't a published estimate. We used to think of it as the whisper number. And the spread sometimes can be, if it's big enough, can be a tell in terms of market reaction on the part of stocks that on the surface seem to have reported that, beaten that sell-side consensus number, but the stock getting hit suggests maybe that whisper number had gotten a little bit lofty. So again, it's not published. It's something you really only glean by watching the action of stocks during reporting season. We also have seen the profit margin, forward profit margin estimates over the next 12 months jumped up to 17, 18%.