US companies' profit growth seen softer, spotlight on AI spending

U.S. companies are expected to report milder third-quarter earnings growth, potentially dampened by a 33% increase in tariffs to $93 billion, though Goldman Sachs anticipates S&P 500 earnings and sales will still surpass consensus with maintained profit margins. Investors are keenly focused on the payback from heavy AI-related capital expenditures, despite AI optimism driving S&P 500 and Nasdaq to record highs and pushing valuations to "frothy" levels of 23x forward earnings. The current government shutdown adds to economic uncertainty, yet an investment banking rebound is projected to bolster major bank earnings.

Analysis

S&P 500 companies are projected to report milder third-quarter earnings growth of 8.8% year-over-year, a notable deceleration from the over 13% growth seen in each of the first two quarters of 2025, according to LSEG forecasts. This moderation is partly attributed to tariffs, which became a larger headwind in Q3, with customs duties rising 33% to $93 billion. Despite this, some analysts, like Goldman Sachs, anticipate S&P 500 earnings and sales will still surpass consensus expectations, with sales growth estimated at 5.7%.

A key investor focus for Q3 results will be the return on heavy capital expenditures related to Artificial Intelligence, despite AI optimism driving the S&P 500 and Nasdaq to record highs. While AI-related megacaps have led the market, investors are increasingly skeptical about the payback period for these significant investments. This skepticism is particularly relevant given the S&P 500's current valuation at roughly 23 times forward earnings, significantly above its 10-year average of 18.7x, indicating potentially "frothy" conditions.

The ongoing U.S. government shutdown, which began October 1, has created an information void by delaying official economic reports, complicating the assessment of economic health and future Federal Reserve policy. However, upbeat economic data from the prior quarter suggests resilience. Furthermore, an expected rebound in investment banking is poised to bolster third-quarter earnings for the six largest U.S. banks, offering a sector-specific positive outlook amid broader uncertainties.

Key Decisions for Investors

• Monitor Q3 earnings reports closely for specific commentary on AI-related capital expenditure payback and future investment plans, particularly from megacap technology companies.
• Exercise caution regarding current market valuations, as the S&P 500 trades significantly above its historical average, especially in AI-driven growth stocks.
• Assess company-specific impacts of tariffs and supply chain resilience, while also considering the potential for stronger performance from the banking sector due to an investment banking rebound.
• Factor in the ongoing economic data uncertainty caused by the government shutdown when evaluating broader market trends and Federal Reserve policy implications.