The third quarter earnings reports of US stocks have begun, AI remains the focus, and tariffs are back in view

The third quarter earnings reports of U.S. stocks will be unveiled next week, with epic gains pushing expectations to high levels, making the earnings season a "moment of truth."

The S&P 500 index has risen 11% so far this year, partly driven by the AI boom. Analysts expect a 7.4% profit growth for U.S. stocks in the third quarter, and investors will be "unforgiving" towards companies that fail to meet expectations.

Against the backdrop of renewed trade tensions and concerns about an AI bubble, American companies need to deliver strong performances to justify the nearly 32% rise in the S&P 500 index since its low in April. Wall Street will focus on a series of potential tricky issues, from the sustainability of AI spending to the impact of tariff increases on corporate profits.

Trump's latest remarks on tariffs have caused trade concerns to regain focus in the market. Deutsche Bank stated that without the impact of tariffs, the S&P 500's third-quarter profit growth could have been one percentage point higher.

This earnings season will kick off with large U.S. banks like JP Morgan releasing their latest financial reports next week, while tech giants will become the focus later this month. CFRA Chief Investment Strategist Sam Stovall said:

"I believe investors will be unforgiving of any missteps—whether it's a decline in earnings or a slip of the tongue when discussing expectations."

Tariff Impact Emerges, Investor Patience Runs Thin

After months of high tariffs, the third-quarter earnings reports are expected to show their impact on companies. Deutsche Bank's analysis indicates that without the tariff impact, the S&P 500's third-quarter profit growth could have been one percentage point higher.

Eric Freedman, Chief Investment Officer at Bank of America, pointed out that while investors granted a "pass" to companies for delaying tariff guidance in previous quarters, this time they are unlikely to be so lenient. "We expect companies to provide more clear information, and investors will respond with greater scrutiny."

Asian countries that exported over $1.3 trillion worth of goods to the U.S. last year have shown relative resilience to tariff increases. However, some fund managers believe this is due to a rush of exports before the tariffs took effect, and they expect a greater impact once this process ends.

For European companies, a series of downward revisions in profit expectations indicate that analysts have taken the tariff impact into account. Citigroup's index shows that expectations have been continuously revised downward since mid-March.

Can the AI Investment Boom Continue?

Global trade uncertainties have not deterred companies from injecting funds into AI investments. UBS expects global capital expenditures to grow by 67% to $375 billion this year. Societe Generale strategists show that capital expenditures as a percentage of sales have reached the highest level in 25 years.

Once companies cut back on AI spending, chipmakers like NVIDIA and "star stocks" in infrastructure and services that have surged due to the AI boom will lose their reasons to continue the celebration. Mike O'Rourke, Chief Market Strategist at JonesTrading, stated that from an investor's perspective, a slowdown would be "like hitting the emergency brake." **

"I expect you will see a lot of stocks enter a real profit-taking mode."

In Europe, industries critical to AI, such as telecommunications companies, power generation companies, and grid operators, may be the biggest losers from the decline in U.S. spending. A custom basket created by Bloomberg tracking 10 such stocks, including Siemens Energy and Orange, has risen 24% this year.

Missing Employment Data Raises Concerns

Investors will also pay attention to companies' statements regarding employee numbers, as concerns about a weak labor market are spreading amid the federal government shutdown and the unavailability of key employment data.

Ross Mayfield, an investment strategist at Robert W Baird, stated that signs of rapid layoffs by companies could exacerbate traders' concerns that U.S. consumer spending will also be weak, affecting a range of retailers, restaurants, and other stocks.

"If we see enough of these situations stacking up, especially in the absence of official data, that would signal that the labor market is weaker than expected."

The Double-Edged Sword Effect of Exchange Rate Fluctuations

Although the dollar rose against most major currencies in the third quarter and is currently close to a two-month high, it remains below levels from a year ago and far from the peak in 2022. This is beneficial for many U.S. companies—the weak dollar makes exporters' products more competitive and helps multinational companies that need to convert overseas profits into dollars.

Jeff Buchbinder, chief equity strategist at LPL Financial, stated in a recent report that the weak dollar, combined with other factors including AI capital investment, could provide an additional 5-7% upside potential to the "current consensus expectations, with third-quarter earnings growing at a low double-digit rate."

On the other hand, European exporters may face headwinds from exchange rates again this quarter due to the still-strong euro. Panmure Liberum strategist Susana Cruz noted that while the euro has weakened slightly in recent weeks, the decline came too late to be reflected in earnings reports