Last month, the concern was whether earnings growth could outrun higher borrowing costs. Earnings delivered. The focus shifted this month to whether growth continues as rates, inflation, and the challenges of building out AI continue to press on margins.

Strong Earnings Results, Higher Expectations

With 88% of S&P 500 companies reporting, third-quarter earnings are up 31.4%, and 84% topping estimates. However, the average beat is only 2.7%, well below the five-year average of 7.5%. Analysts raised estimates heading into the quarter, so companies were clearing a higher bar. As a result, the market is paying less attention to the beat itself and more to guidance and cash flow. With high interest rates, durable cash will be important for future growth.

Interestingly, stocks have become cheaper even as the market and prices have risen throughout the year. The forward P/E is around 17.7x, down from roughly 22x in January. Earnings have grown faster than stock prices, lowering the P/E valuation metric. Profits look healthy. Investors aren’t willing to pay as much for growth that’s still years away and may not materialize amid market noise.

From Capex AI Spending to AI Accountability

For the past two years, the market rewarded companies for spending heavily on AI. That’s changing. Investors now want to see what that spending is producing.

Data-center development continues to face delays from higher financing costs, limited power availability, and regulatory uncertainty. Only 1/3 of the large US projects planned for 2026 are under construction. These slowdowns don’t signal weaker demand, with US vacancy rates below 3%. Demand hasn’t disappeared, but these delays push back returns on investment, revenue, and profits, which weigh on valuations.

Nvidia’s leadership changes, ahead of its November 17 earnings, created uncertainty for the company and the AI supply chain. Microsoft’s outage demonstrated how businesses now depend on a few cloud providers. These events don’t change the long-term demand for AI and technology. The market is rewarding companies with cash flow and earnings visibility over those relying on increasingly expensive borrowed money.

The Fed’s Growing Inflation Dilemma

The Fed is in a difficult position. Inflation is hot, jobs are good, and interest rates are high. October’s CPI came in hotter than expected, the job market is still solid, and markets are now pricing in a likely rate hike in December.

The 10-year Treasury yield is back above 5%, making borrowing more expensive and stocks less attractive by comparison. Additional pressure on long-term yields comes from the government funding the national debt: a deficit of roughly $2 trillion a year means heavy Treasury issuance, and that pressure won’t go away even if inflation eases. Oil price volatility adds another layer of uncertainty. The economy can handle higher rates, but as long as inflation stays sticky, the Fed can’t do much to help if growth slows. With high inflation, markets expect the Fed to keep raising rates.

Rotation to Fundamentals

Money is moving out of expensive tech names and into companies with solid cash flow, dependable and durable earnings, and strong balance sheets. We see this as a rotation rather than a retreat from stocks. Tech still carries risk around AI spending. Companies should have visibility and guidance into the future. Other sectors have their own problems, including high rates, a slowing consumer, and geopolitical risk, with oil higher. However, a broadening market based on solid company fundamentals would be healthy for the market’s direction. A market led by more companies is a sturdier one.

The Path Forward

The market outlook remains cautiously constructive on stocks over the next 9 to 18 months. Earnings are growing, employment is steady, valuations have come down, and the economy is performing well. Inflation and rates are pain points, and AI projects are facing regulatory and sentiment issues; we stay selective on best-of-breed.

We’d become more defensive if earnings estimates start falling across sectors, AI delays begin to hurt profits seriously, or inflation causes more aggressive Fed hikes. However, stabilized yields, solid company guidance, and steady jobs give us more confidence.

The bull market remains intact, but investors are holding it to a higher standard. The market is looking for performance, not empty promises. Strong earnings remain important, and so does showing that those earnings turn into real cash.