U.S. stock Q3 earnings season begins; AI remains the focus, tariffs back in view.

U.S. stock market Q3 earnings reports will kick off next week, with epic gains pushing expectations to a high level. Earnings season has become the "moment of realization."

The S&P 500 Index has risen 11% so far this year, partly fueled by the AI boom. Analysts expect U.S. stocks to post 7.4% profit growth in Q3, and investors will be "unforgiving" toward companies that miss the mark.

Against the backdrop of renewed trade tensions and underlying concerns about an AI bubble, U.S. companies need to deliver strong results to justify the nearly 32% gain in the S&P 500 since its April low. Wall Street will be watching a range of potentially tricky issues, from the sustainability of AI spending to the impact of tariff hikes on profits.

Trump's latest comments on tariffs have made trade concerns a market focus again. Deutsche Bank says, if not for the impact of tariffs, S&P 500 Q3 profit growth could have been one percentage point higher.

This earnings season will start with major U.S. banks such as JPMorgan Chase announcing latest results next week, while tech giants will be in focus later this month. CFRA’s chief investment strategist Sam Stovall stated:

"I think investors will be utterly unforgiving of any missteps—whether it's profit declines or slips of the tongue when discussing forecasts."

Tariff impact emerges, investor patience runs out

After months of high tariffs, Q3 earnings reports are expected to reveal their impact on companies. Deutsche Bank analysis shows that S&P 500 Q3 profit growth could have been one percentage point higher without tariff effects.

Bank of America chief investment officer Eric Freedman points out that while investors previously gave companies a "pass" for delaying tariff guidance over the past few quarters, it’s unlikely they’ll be so lenient this time. "We expect companies to provide more explicit information, and investors to adjust their tolerance accordingly."

Asian countries that exported over $1.3 trillion in goods to the U.S. last year have shown relative resilience to tariff hikes. However, some fund managers believe this was due to a "rush" to export before tariffs took effect, and expect a greater impact once that phase ends.

For European companies, a series of downward earnings revisions indicate analysts have factored in the tariff impact. Citigroup indexes show expectations have continuously declined since mid-March.

Can the AI investment boom last?

Global trade uncertainty has not halted companies from pouring funds into AI investment. UBS estimates that global capital expenditure will increase 67% this year to $375 billion. Societe Generale strategists' data shows the ratio of capital expenditure to sales has hit a 25-year high.

Once companies scale back AI spending, chipmakers like Nvidia and the "star stocks" in infrastructure and services that have surged on the AI boom will lose their reasons for continued celebration. Mike O'Rourke, JonesTrading’s chief market strategist, says, from an investor perspective, a slowdown would be "like slamming on the brakes."

"I expect you'll see lots of stocks enter real profit-taking mode."

In Europe, sectors vital to AI—like telecoms, power companies, and grid operators—may be the biggest losers if U.S. spending weakens. A custom Bloomberg basket tracking 10 such stocks, including Siemens Energy and Orange, is up 24% this year.

Missing jobs data increases scrutiny

Investors will also pay attention to companies' comments on staffing levels, as worries over a weakening labor market grow due to a federal government shutdown and the lack of key employment data.

Ross Mayfield, investment strategist at Robert W Baird, states that signs of rapid layoffs will raise traders' concerns about weaker U.S. consumer spending, impacting a range of retailers, restaurants, and other stocks.

"If you see enough cases like this piling up, especially in the continued absence of official data, that's a signal the labor market is weaker than expected."

Currency fluctuations a double-edged sword

The dollar has risen against most major currencies in Q3 and is near a two-month high, but is still below last year’s levels and far from the 2022 peak. This benefits many U.S. companies—a weaker dollar makes exporters' products more competitive and helps multinationals convert overseas profits into dollars.

Jeff Buchbinder, chief equity strategist at LPL Financial, said in a recent report that dollar weakness, together with factors including AI capital investment, could provide "another 5-7% upside for current consensus expectations, with third-quarter profits growing at a low double-digit pace."

On the other hand, as the euro remains strong, European exporters may face more headwinds this quarter. Panmure Liberum strategist Susana Cruz notes that while the euro has softened slightly in recent weeks, the decline came too late to show up in the earnings reports.

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