Why the AI Trade is Moving Up the Stack

Equity Market Resilience Despite Rate Pressures

• S&P 500 resilience is primarily driven by earnings strength in large AI-related tech stocks rather than broad market valuation support.
• Valuation multiples for the S&P 500 have declined significantly over the last year to offset higher yields.
• Cyclical and rate-sensitive stocks have moved lower as yields have risen, contrasting with the performance of AI beneficiaries.
• The broader market narrative is described as "micro driving macro," where specific sector strength dictates overall index performance.

AI Investment Themes and CapEx Visibility

• Market consensus on AI Capital Expenditure (CapEx) visibility is forming around calendar 2027, providing 12–15 months of visibility.
• Visibility beyond 2027 remains limited, contributing to multiple compression in semiconductor valuations.
• Investor focus is shifting "up the stack" from infrastructure to the inference economy, including cybersecurity and data infrastructure tools.
• Product successes, such as "Muse," have reignited enthusiasm, though the narrative has evolved from a pure CapEx trade to one involving enterprise and consumer deployment.

Market Breadth and Sector Rotation

• Market breadth is at extreme narrowness, with the median S&P 500 stock trading more than 15% below its high.
• This breadth metric is the narrowest since the dot-com bubble, raising questions about sustainability versus potential reconvergence.
• Historical data suggests narrow breadth more frequently resolves with a "cash up" (broadening rally) rather than a market crash, though timing remains difficult to predict.
• Strategists recommend a balanced approach: holding AI themes while targeting beaten-down sectors like consumer experience stocks, which trade at low multiples.

Q3 Earnings and 2028 Outlook

• Q3 earnings season begins the week following the conversation, with consensus estimates calling for approximately 30% earnings growth.
• Earnings growth is expected to decelerate heading into 2027 due to macro forces and a potential slowdown in the growth rate of AI CapEx.
• Hyperscalers' Return on Invested Capital (ROIC) remains a central metric for market validation and positive reinforcement.
• Semiconductor companies providing visibility into 2028 will be a key differentiator for stock performance and multiple support.

Forward-Looking Consumer AI Applications

• The market is increasingly focused on the "personal agent" story, seeking to gauge its scale and speed of adoption compared to established coding applications.
• Investors are looking for evidence of cost savings, new revenue streams, and business formation tied to consumer-side AI applications.
• Future market direction will depend on the clarity of AI's impact on the consumer stack and enterprise deployment tools.

Elections and Year-End Market Outlook

• Political risk premiums typically build before midterms but are expected to begin relieving in October, a dynamic currently well-priced or less dominant due to AI focus.
• Investor positioning is described as "light," and valuations are considered reasonable despite the S&P 500 nearing record highs.
• The base case scenario for Goldman Sachs strategists is a higher market into year-end, supported by underlying earnings strength and reduced political uncertainty.
• The consensus view anticipates no major policy changes in the immediate term, reducing election volatility impact compared to previous cycles.