Mag 7's AI Show Me Story: Why Earnings Need to Meet Exceedingly High Bar

Sam (0:00)

Welcome in our next guest, Jed Ellerbroek, Portfolio Manager at Argent Capital Management. Good afternoon to you, Jed. So the banks kicked things off. Things look pretty good. I mean, credit quality is holding up. NIMS look a little bit shaky, but just walk us through how you would characterize the kickoff to the earnings season so far.

Jed Ellerbroek (0:19)

Hey, Sam and Marlee, good to be with you guys. Yeah, you're right. I think the biggest takeaway for me from bank earnings thus far is that deposit costs are rising, and rising more than people expected. On the other side, I think loan growth is still pretty good. You said credit was good. That's right.

I think trading results for the Wall Street-oriented banks was pretty good, not as good as last quarter's blowout, but still pretty good. Of course, wealth management, investment management continue to do pretty well on the backs of rising equity markets.

Overall, I think a pretty good earnings season. Most of the banks that have reported so far have seen their earnings estimates for 2027 tick up a hair. All in all, I think good news.

Marlee (1:05)

Jed, we've got Big Tech about to take center stage here. You're expecting strong growth and profitability alongside higher capital spending projections. How much of that optimism is already priced into these names?

Jed Ellerbroek (1:21)

Yeah, I observe a disconnect between really outstanding results from companies like Google and Amazon and Microsoft and Meta. Those companies have been reporting really strong revenues and profits for many quarters now. Earnings estimates have been going up for almost all of them. They're all reinvesting really aggressively in their business, which is a good sign usually. So the businesses are performing well, but we've seen valuations decline steadily this year for those companies and they're currently on the low side, I think really for all of those.

So what explains that disconnect? I think the single biggest thing is all of those companies I mentioned, all four of them are taking virtually all of their profits and reinvesting to build data centers. And investors are just uncomfortable with that level of spending, that level of commitment and conviction in data center construction spending. And I don't really think that strong third quarter results, even if we see accelerating revenue growth from Amazon's AWS and Microsoft's Azure and Google's GCP, we're going to see acceleration from all three of those. I don't necessarily think that that's going to be enough to convince investors to drop their skepticism regarding the data center investment. I think what it might take is the growth rate in revenues being higher than the growth rate in CapEx spending for those companies. And we're not at that point. We're not going to be at that point until the second half of 2027, I think.

Sam (2:53)

Which is when a lot of these companies which turn negative, pay free cash flow are likely to turn positive free cash flow again. We'll have to wait and see. But we've very much seen the Mag 7 re-establishing market leadership in recent months. And you feel like the earnings was a big catalyst for that just because they started to show signs of proof of monetization, I should say.

I'm wondering just how high the bar is going into Q3 now, what they have to prove in order to see that sustained rally into the end of the year, because it was that sort of handful of stocks that got us to those record highs in recent weeks. I mean, without them, obviously, we've seen what the market can do.

Jed Ellerbroek (3:39)

Yeah.

Gosh, the market moves so fast. You know, I mean, last week and the couple weeks preceding it, we saw an equity market led by the biggest tech companies, those cloud computing giants and, you know, Nvidia did well too. But this week was a really sharp reversal in that. Big tech performed pretty poorly this week.

So, yeah, we're just seeing really, really high single stock volatility in markets. I think that's going to continue. Volatility around earnings season is even greater than outside of it. You know, so we're in for a wild next few weeks, I think. If you look at, like, you know, what's the bogey that these companies need to beat? Amazon's AWS, for example, they grew their revenue 37% last quarter. That was up from 28% the quarter before. Those are great numbers. I think investors expect something like 42 or 43% in this third quarter that they're going to report in two weeks. Can they accelerate beyond that number? I think that's kind of what it'll take. And I think for, you know, for Microsoft, Azure Business is probably something like 46 or 47% growth that investors are expecting there.