Earnings Lead the Way, But Capital Gets Expensive
Earnings give the market a solid footing heading into the fourth quarter. The problem is the cost of money. With the 10-year Treasury above 5% and Brent crude over $100, inflation is running hotter than the Fed would like, and stocks aren’t cheap. So far, strong profits and heavy AI spending have kept the market steady.
The main question for October: can earnings grow fast enough to overcome the rising cost of money?
Earnings Remain the Market’s Strongest Foundation
Third-quarter earnings season will be October’s defining catalyst. FactSet projects S&P 500 earnings growth of 29.6% year-over-year, potentially the third straight quarter above 25%, and a record 72 companies have issued positive EPS guidance. Companies historically beat estimates, and FactSet suggests reported growth could top 35%.
With expectations this high, beating estimates won’t be enough. Investors want durable margins, improving forward guidance, and earnings strength that broadens beyond the technology and AI leaders. Strong earnings can keep the market moving higher, but the rally will last longer if that strength spreads to more companies.
Higher Yields and Oil Are Raising the Stakes
The biggest challenge to equities is the price of money. With the 10-year Treasury hitting 5.31%, bonds offer a more competitive alternative, borrowing costs are higher, and valuations are under pressure, especially for companies that depend on future growth.
September inflation accelerated to 3.7%, above the Fed’s 2% target, driven by energy and shelter costs. The hotter data raised the odds of a Fed rate hike this year. Producer prices, which measure what businesses pay before goods reach consumers, rose 6.3% from a year ago in September, well above expectations. Rising business costs can work their way into consumer prices in the months ahead, which gives the Fed another reason to keep rates higher for longer. Higher costs also make pricing power, a company’s ability to pass them on to customers, an important quality in the companies we own.
With WTI near $95 and Brent above $105, energy costs keep inflation elevated, hurt margins, and dampen consumer sentiment. Retail sales beat expectations in September, though gas accounted for much of the gain. That leaves the Fed balancing a growing economy against sticky inflation, with no easy way to ease policy.
It matters why yields are rising. If it’s because the economy is growing, stocks can handle it. If it’s because inflation won’t come down, that’s a bigger problem, especially if rates and prices climb faster than earnings.
The Market Rally Needs to Widen to Other Sectors
AI continues to drive investment and earnings growth. The next phase in the bull market will require proof of sustainable revenue, free cash flow, and profitability. Strong index performance can hide weakness when a few companies drive most of the gains. Earnings growth and performance from industrials, financials, healthcare, and other sectors would produce a healthier market.
Our Outlook: Stay Invested. Stay Selective.
We remain constructive on equities. The economy is resilient, earnings are expanding, and early bank results show consumer spending and business investment holding up despite the higher-rate environment.
Valuations have come down this year. The S&P 500’s forward P/E declined from roughly 22x in January to 19x today. Stocks still aren’t cheap, but there’s less valuation risk than there was, even as earnings expectations have gone up.
We don’t need yields and oil to drop sharply for stocks to keep climbing. If they simply level off, attention should shift back to earnings, and we’d expect more sectors to join the rally. We’re staying invested, but we’re being careful about what we own.
