October’s market split: an AI reset meets resilient growth

The headline falls in global equity markets concealed a much broader rotation. Developed-market equities declined by 0.8% in October and emerging-market equities fell by 8.0%, with technology-heavy Asian markets particularly weak. Yet performance outside the largest technology companies was considerably more resilient. Investors became more selective about which businesses could convert investment and revenue growth into sustainable cash flow.

At the same time, high-quality government bonds provided a counterweight. Aggregate Bonds returned 1.4% in US-dollar terms as yields retreated from early September’s highs.

This bond rally occurred despite evidence that the major economies were still expanding at a strong rate. The advance estimate showed US gross domestic product growing by 0.8% during the third quarter, equivalent to an annualised rate of 3.4%. Preliminary data show euro-area output increased by 0.4%from the previous quarter.

Business surveys told a similar story. The October US composite purchasing managers’ index remained firmly in expansion territory, while the eurozone survey indicated a slower but continuing increase in activity. Both surveys also pointed to renewed cost pressures, reinforcing the tension between resilient growth and inflation risk.

Oil added to that tension. Renewed conflict in the Middle East pushed Brent crude to $118 a barrel during the month. Higher oil prices supported energy companies but increased the risk of more persistent inflation.

The UK Budget left the gilt rally intact

The UK Budget was presented to Parliament on 28 October. Its measures included support for household energy costs and fuel duty, alongside additional funding intended to encourage longer-term investment.

For markets, the overall message was one of fiscal stability rather than significant change. Fiscal rules were maintained, headroom was broadly as expected at £15 billion and planned long-dated gilt issuance will fall. Gilt yields edged lower during the Chancellor’s speech, suggesting that the announcement did little to disturb the supportive backdrop for UK government bonds.

US earnings remain strong, but investors want evidence of durability

Third-quarter US earnings have so far been strong. With 60% of the largest US equities having reported by 30 October, blended earnings growth was 30% compared with the same period a year earlier. Some 82% of reporting companies had exceeded earnings-per-share estimates, and all 11 sectors were showing positive year-on-year earnings growth.

Leadership has also started to broaden beyond of the biggest technology names. Companies outside the “Magnificent Seven” (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla) are now reporting faster profit growth than the group itself. This is encouraging because it suggests the profit cycle is not dependant on a very small group of companies.

AI investment remains central to the outlook. Spending on data centres, semiconductors, computing capacity and power infrastructure is supporting economic activity and driving strong revenue growth for companies in the AI supply chain.

However, the scale of this investment is increasing scrutiny of how it is financed and whether it can produce sustainable margins and cash flow. October’s weakness appears to mark a change in emphasis rather than the end of the AI investment cycle. Investors still recognise AI’s long-term potential, but increasingly want evidence that higher spending can generate attractive returns.

Our central view is that the large technology platforms are likely to earn attractive returns from their AI investment in aggregate. The path will not be smooth, however, and company valuations and share prices remain sensitive to changes in revenue expectations, investment spending and free cash flow.

A rotation beneath the US equity index

US Equities fell in October, but the headline index did not capture the experience of most companies. Weakness was concentrated among several of its largest technology and communication-services constituents, whose substantial index weights outweighed stronger returns elsewhere.

Energy companies benefited from higher oil prices. Healthcare, consumer staples and utilities attracted investors seeking more visible earnings and steadier cash flows. The result was unusually wide dispersion between companies and sectors.

A fall driven by deteriorating profits broadly across the market would be a more concerning signal for the economic and market outlook. October instead looked primarily like a reassessment of price, concentration and the prospective returns on AI investment.