The S&P 500 braces for a storm

The equity market is beginning to feel the double blow of concerns about the sustainability of artificial intelligence spending and accelerating inflation driven by the conflict in the Middle East. Previously, stock indices had been buoyed by expectations of strong third-quarter corporate earnings, but this high concentration of profit growth in a few companies is casting doubt on the sustainability of those gains. According to Wall Street forecasts, just two companies, NVIDIA and Micron, will account for more than a third of the S&P 500’s expected 30% profit growth.

Ten companies, including Broadcom and Meta Platforms, account for two-thirds of expected profit growth. A significant portion of this is linked to oil and gas giants benefiting from rising energy prices. On the other hand, the remaining 490 S&P 500 companies are forecast to see a 10% rise in profits, which is also considerable for a bull market now in its fifth year.

At the same time, investors are well aware that such impressive financial results will not last indefinitely. Artificial intelligence technologies are increasingly reliant on borrowed funds, while rising bond yields are driving up costs and reducing profits. The third-quarter corporate earnings season offers insights into how this process is unfolding and whether investors should reduce the weighting of tech giants in their portfolios.

In the final week of October, markets will be closely monitoring the results from Microsoft, Alphabet and Amazon. Coupled with central bank meetings, including the Fed’s, these could seriously unsettle the S&P 500. For instance, Fed Chair Kevin Warsh’s hawkish rhetoric risks a renewed rally in US Treasury yields, which would be negative for the equity market.

According to Bank of America, the markets’ risk-off sentiment is set to continue until December. A flight from artificial intelligence stocks, geopolitical tensions and expectations of a resumption of the Fed’s monetary tightening cycle are by no means an exhaustive list of factors holding back growth in the S&P 500. Investors will be looking ahead to the results of the upcoming US midterm elections. A Democratic victory threatens to slow corporate earnings. The Democrats will begin to throw a spanner in the works of the current administration, which is focused on tax cuts and deregulation.