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On Housing’s Recession, Brazil’s Election & Rising Profit Margins
The US housing market has entered a downturn. Sales activity is low, depressed by low demand given high mortgage rates and affordability constraints. Homebuilders have been hit hard, but the downturn hasn’t yet depressed prices for existing homes, Melissa reports. They’ve been supported by low inventories, as would-be home sellers with low mortgages have been opting to stay put. … Also: William discusses what may be ahead for Brazil’s economy and markets now that left-leaning President Lula has been reelected. … And: Is AI adoption improving corporate profit margins yet? Joe’s data suggest so.
Industrials: AI Jitters Versus Booming Orders
I. AI Still Boosting Capital Goods Orders The AI investment boom has been a double-edged sword for S&P 500 Industrials this year. Back in July, we noted that the sector was the second-best performer among the S&P 500's 11 sectors, with a 17.7% ytd gain, as investors favored companies supplying the equipment and infrastructure needed for the AI buildout. Since then, however, intensifying AI jitters have weighed on industrial stocks, fueled by a potentially toxic trifecta of financial constraints: elevated borrowing costs, uncertain investment returns, and concerns about whether sufficient capital will be available to finance everyone's ambitious AI spending plans. The corresponding reversal has been significant. As of October 27, Industrials was up just 8.2% ytd, compared with a 12.8% gain for the S&P 500, slipping to sixth place among the 11 sectors (chart). The sector's stock price index is trading below its 200-day moving average but remains on a solid multi-year uptrend (chart). Performance within the sector has been uneven so far this year, with rail transportation leading, while industrial machinery and aerospace and defense lagging (chart). We think the recent selloff is overdone and continue to recommend overweighting Industrials. For starters, the sector's earnings outlook remains upbeat. Forward earnings rose 13.6% ytd to a record high last week (chart). The sector's forward profit margin is also at a record high of 11.7% (chart). Analysts' net revisions of their revenues and earnings estimates have also improved significantly in recent months, with both remaining historically elevated (chart). Furthermore, analysts still expect double-digit earnings growth of 17.6% in 2026 and 16.5% in 2027 (chart). The sector's forward P/E has fallen sharply recently, but remains above the overall market's valuation multiple (chart). The AI investment boom continues despite the stock market's jitters about the AI trade. The five major hyperscalers (Amazon, Alphabet, Microsoft, Meta, and Oracle) are projected to spend nearly $800 billion on capex this year and more than $1 trillion in 2027. So far this week, there has been roughly $235 billion in announced AI financing, including up to $95 billion from Meta, a $40 billion chip-and-server leasing arrangement involving SpaceX, and a potential $100 billion IPO by Anthropic. We therefore continue to recommend overweighting Industrials, which should continue to benefit from the buildout. Indeed, the AI spending boom is still boosting industrial activity, with much more in the pipeline. Consider the following: (1) Durable goods. September durable goods orders rose 1.8% m/m, the largest increase in five months. Orders excluding transportation increased 0.5%, while core capital goods orders (nondefense excluding aircraft), a key gauge of business investment, rose 0.5% and 13.5% y/y to another record high (charts). The major components of durable goods orders are at record highs (chart). Orders for machinery necessary to operate data centers are especially strong (chart). Unfilled orders for computers and electronic products rose to a record $162.4 billion in June (chart). (2) Regional business surveys. All five regional Fed manufacturing surveys are now available for October. The regional manufacturing PMI edged down to 13.8 from September but remained comfortably in expansion territory, suggesting that the national ISM M-PMI likely remained above 50.0 in October (chart). The average prices-paid index across regional Fed surveys stood at 57.0, near levels last seen in 2022. Meanwhile, the prices-received index climbed to 31.6, suggesting that manufacturers are increasingly passing higher input costs on to customers (chart). II. US Economy The industrial sector isn't the only driver of the US economy showing remarkable strength. Another key driver of economic resilience is consumer spending. Here is more: (1) Consumer spending. Redbook same-store sales rose 9.7% y/y during the week of October 16. That is well above the 2025 average of 5.8% (chart). (2) Labor market. Consumers' perceptions of labor-market conditions improved in October. The percentage saying jobs were plentiful rose to 26.7%, the highest since April (chart). The latest weekly ADP data show private-sector employment rising by an average of 16,750 jobs per week over the four weeks through October 10, or roughly 67,000 jobs on a monthly basis (chart). The labor market remains in good shape. (3) GDP. Ahead of Thursday's release of the Q3-2026 US GDP report, the Atlanta Fed's final GDPNow estimate suggests that the economy expanded at a robust 3.4% annualized rate during the quarter, supported by strong consumer spending and business investment (chart).
On BOJ & ECB Decisions Ahead, European Stocks & Britain’s New Prime Minister
The central banks of Japan and Europe will make decisions on interest-rate policy this week. … William says this is no time for the BOJ to pause its tightening as expected. The stakes are too high. … The ECB likewise is expected to pause. Its ability to focus solely on inflation is compromised by the debt problems of some countries, which are driving up bond yields and doing some of the ECB’s tightening work for it. … Toby observes that European stocks may have been overly discounted amid the debt problems, as the earnings outlook remains good. … Britain’s debt markets seem confident that PM Andy Burnham is no Liz Truss. Now he has to prove it.
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