We remain pleasantly surprised with the continued stability in equity values this past quarter even though fundamentals appear to be diverging. The S&P500 Index increased by 2.3% this past quarter and is now up 12.7% for the year. Fixed income (bond) prices were more volatile than normal in Q3 as prices dipped by almost 2%, as interest rates across the curve rose above prior range-bound levels. Moreover, oil and inflation also moved alarmingly higher during the quarter; which has many investors wondering about valuations as these important fundamentals deteriorate. We view the stability in equities as being supported by strong earnings growth (above 20%) in the first two quarters and the expectation for similar earnings growth to continue for the 2nd half of the year and into 2027.
Management teams across industries provided upbeat guidance for earnings growth for the balance of 2026 when they reported in July-Aug. We’re looking for much the same (or better) in the Q3 reports
(Oct-Nov) about to begin.
As we’ve discussed, the US economy benefits significantly from its global leadership in the AI economy. US companies Nvidia, Broadcom, Alphabet, Microsoft, Amazon, Meta, Anthropic, OpenAI & SpaceX will continue to capture most of the global growth from AI as the necessary infrastructure is built out over the next decade. We recognize that energy, geography, cost of capital, security as well as AI product demand & pricing all remain potential impediments to growth; and we’ll remain vigilant as to the impact of an unexpected deceleration in the AI economy. Generally, our AI portfolio risk management strategy has been to own the most profitable industry leaders with the strongest balance sheets, and to trim outsized gains on strength; then to redeploy funds and diversify across other, more attractively priced sectors of the economy.
The AI impact on job growth and wages so far has been positive and has contributed to more resilient consumer spending than expected. Labor and consumer trends going forward will be important to watch as companies look for productivity gains; a positive trend would be capturing additional earnings through new, more creative products and services while a negative trend would be for additional earnings to simply be the result of using AI to cut the workforce.
We’re not too concerned about inflation trends impacting long-term interest rates more significantly than what’s already been experienced. In the AI productivity / job reduction situation described above,
either way it plays out will be disinflationary. While the outcomes of the wars in Ukraine and Iran are uncertain, supply chains are being reworked, and higher oil prices will ultimately result in both lower
demand & higher production leading to eventual disinflationary pricing. However, we do have concerns (less so for the US) regarding government finances as a key growth fundamental to watch over the next several years as too many large economies are being supported by too much deficit spending.
Over the next quarter or two, we continue to believe that the main driver of equity performance will be the growth in the AI infrastructure economy and the strength of earnings growth throughout the economy. As earnings continue to rise over time, valuation risk declines. As we enter the fifth year of this bull market, our expectations remain positive for continued modest and stable equity returns.
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SFE Investment Counsel is a Registered Investment Adviser. This presentation is solely for informational purposes and not a solicitation to invest. The results reflect the
deduction of fees and the reinvestment of dividends and other earnings. Advisory services are only offered to clients or prospective clients where SFE and its representatives
are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may
be rendered by SFE unless a client service agreement is in place. Please contact a financial advisory professional before making any investment.
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