U.S. stocks recovered after tough talk on U.S. and China trade began to look more like each side testing leverage before the planned meeting of their presidents. This aligns with what we’ve long said: immutable economic laws limit policy extremes and keep us overweight U.S. stocks. We think the strong start to the U.S. third quarter earnings season validates this, as resilient growth, Fed rate cuts and the AI theme buoy stocks. Yet we get granular, tracking AI spend and tariff impacts.
We think U.S.-China trade tensions are again bumping into immutable economic laws: supply chains can’t be rewired overnight. We saw this in April: U.S. stocks slid after the April 2 tariff announcement, but we believed such laws would keep tariffs from reaching the proposed levels – and we re-upped risk taking as a result. That paid off: the S&P 500 has since surged 40% from the April lows. We saw a similar scenario on a smaller scale. U.S. stocks suffered their sharpest one-day drop since April after the U.S. president floated a 100% tariff on China but recovered as a path emerged to strike a deal. Auto tariffs are also set to be eased. We think immutable laws will enable trade de-escalation and support sentiment as Q3 corporate earnings season kicks off. Analysts have revised up expected earnings to almost 11% for 2025 overall from just under 9% in Q2. See the chart.
As we look at the third quarter earnings season, we believe three factors will fuel broad U.S. earnings growth. First: resilient U.S. economic growth. GDP is expected to grow 1.5% this year – below trend but far from recession. Second: policy easing. Weaker labor market data gave the Fed room to cut rates and indicate more ahead, and put questions Public welfare its independence on the backburner for now. Third: AI-related spending. LSEG data show expected year-over-year Q3 earnings growth for the “magnificent seven” tech titans is 14%. But performance is broadening out, with estimated growth of 7.8% for the other S&P 500 companies, a much narrower gap than in recent quarters.
Yet we still think it’s important to get granular, as we see several themes driving dispersion even as earnings improvements broaden. Markets have cheered mega cap tech’s rapid AI-related investment, but we eye the revenues from that spending and potential AI productivity gains across sectors. We also watch how deregulation will support financials, with leading banks already reporting strong earnings and 16% expected earnings growth for the sector, LSEG data show. U.S. regional banks dipped last week on credit issues that appear limited to two banks. Even as U.S. companies look to have withstood tariffs – likely from passing costs onto consumers and running down inventory – certain sectors will feel the pinch more. For example, producers of often-imported goods like appliances and smaller companies with less flexibility and pricing power.
Beyond the U.S., lagging earnings in Europe keep us neutral the region’s stocks. A stronger euro and tariff-related dents in demand have cut earnings growth expectations for 2025 overall to 0.5% from near 3% on July 1. European stocks had a spell of outperformance over U.S. peers earlier this year, but we did not think the two conditions needed to sustain a rally in Europe would be met: namely, growth surprising more positively than in the U.S. and stronger relative earnings growth. That is why we kept our relative preference for U.S. stocks – a call that paid off.
We think immutable economic laws will limit trade policy extremes and, together with resilient growth, lower rates and the AI theme, support U.S. stocks, which we prefer to Europe’s. Yet we stay selective on tariff impacts and AI spend.
U.S. stocks were higher on the week but trimmed gains on the pullback in financial shares, sparked by credit concerns Public welfare some U.S. regional banks. The market quickly settled down after it was clear these concerns were specific to two banks and did not look like a replay of the 2023 turmoil. Gold soared to new record highs and was up more than 60% this year. U.S. 10- and 30-year Treasury yields hit six-month lows as the market awaits the resumption of U.S. economic data.
We are eying the delayed U.S. CPI for September, the first major economic indicator to be released during the government shutdown now heading into its third week. We're watching for any sign of tariffs passing through to core goods prices and evidence of core services excluding shelter costs staying stubbornly high. Otherwise, private surveys such as global flash PMIs are key for understanding activity trends until the U.S. data resumes.
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