Forget trying to pin the tail on the donkey. This is pinning the tail on a bucking bronco.
As the global economic order reorganizes tweet by tweet, volatility is everywhere in the market. Recession odds are swinging wildly in real time, while tariff wars toggle on and off. Trying to predict trade policy is like betting on a poker game in a wild west saloon. You never know who’s bluffing until the cards are on the table.
This is significantly disrupting supply chains as businesses scramble to make sense of it all: Should I pull forward inventory levels? How can I get clarity on my customers’ long-term demand? How long will this last?
We don’t know, and uncertainty is paralyzing.
All this is to say that the S&P 500 is now… flat on the year. The market has rallied well above pre-liberation day levels as if nothing ever happened.
Over the medium term, some of this is signal, but most of it is noise.
In the midst of all this volatility, it is very important to ask: What are the long-term secular trends that will endure?
Taking the Long View
Over the short term, the stock market is a voting machine. Over the longer term, it’s a weighing machine, and stock prices over the longer term have a 100% correlation with earnings growth.
To find companies with earnings growth, you must first identify long-term secular themes. The most prevalent theme in the market right now, by a long shot, is the proliferation of artificial intelligence. Although adoption is exponentially increasing (40% of American workers now use AI), we are still in the early days. As we introduce more use cases and, at the same time, call on models that are using reasoning and inference (a.k.a. the model now “thinks” through the problem iteratively), all roads lead to more compute.
This means we still have at least 12-18 months of infrastructure buildout ahead of us. Will the CapEx cycle end? Yes – all of them do. But I think the market is drastically underestimating the buildout that will still be required in 2026. We are nowhere near peak data centre yet.
What we are also starting to see is the benefits of artificial intelligence expanding beyond just technology companies. Sure, tech companies are the low-hanging fruit when it comes to adoption because they need to eat their own cooking, but we are now seeing the “adopters” start to benefit instead of only the “enablers.”
Here are several examples in retail:
- Walmart has implemented predictive systems that optimize store-level inventory replenishment, resulting in up to a 15% reduction in operating costs and notable improvements in product availability.
- The cosmetics chain Sephora has integrated AI algorithms into its digital ecosystem to offer ultra-personalized recommendations to customers based on purchase history, aesthetic preferences, and site behaviour. According to InfoRetail, this has led to a 30% increase in average cart value.
- Starbucks, Intermarché, Liverpool, and Coppel show similar AI wins in loyalty, checkout, and logistics, and 90% of surveyed retail executives have already run AI pilots.
- Research cited finds AI cuts operating costs 15–20%, raises inventory accuracy 30%, and lifts sales 10–15% via personalization.
And that’s just retail. The immediate beneficiaries of AI were call centres, software development, and legal documentation. Now, we’re seeing it expand to nearly every facet of work. With the increased momentum now in robotics, even physical labour jobs that were previously thought to be impossible to automate are at risk. AI is coming for every job in every industry.
However, this does not mean we’re doomed. Much like the agricultural revolution shifted work from the fields to the office, the type of work in this revolution will change. Those who embrace this technology to empower themselves will greatly benefit from this shift. Those who ignore it will be left behind.
Impressions From Earnings Season
Tech companies had a free pass that they didn’t take.
As the market was starting to price in a doom-and-gloom scenario around the highest tariff rate seen in about 70 years, it would’ve been easy to cautiously guide down numbers and build in room for tariff downside. But they didn’t do that.
Instead, the most valuable company in the world put up one of its most impressive quarters in a very long time, defying the gravity of tariffs.
The reason? The unstoppable force of artificial intelligence.
Microsoft grew their Azure cloud revenue 35% YoY, 16% of which is attributable to AI. By some estimates, Microsoft has now crossed a $17B run rate in their AI business, with a majority coming from its Azure cloud hosting business, which benefits from AI consumption. This business was zero two years ago. As humans, we often fail to extrapolate exponentially, as our minds default to linearity. This is one of those times when the numbers can grow very, very quickly.
So far, this technological revolution is particularly unique because the incumbents seem to be adequately prepared to react to it. The megacaps have had decades of impenetrable moats that have led to strong revenue growth, high margins, and large cash war chests. This has enabled this buildout cycle to be funded entirely by either free cash flow or cash on the balance sheet instead of debt.
No one can fund this buildout like megcaps can. Last year, Canada pledged $2.4B to “secure Canada’s AI advantage”. Microsoft will spend $80B on CapEx this year. Make no mistake, they are spending like cowboys on this stuff: $350B+ in CapEx this year across the megacaps. But what they are seeing is the opportunity ahead, which I firmly believe will materialize.
In 2024, the Mag7 accounted for a staggering ~73% of earnings growth for the S&P 500. Post-election bottom-up consensus estimates pointed towards a broadening of earnings growth, with Mag7 contributing just ~33%. Given the slowing business cycle and sequencing of Trump administration policies, especially around trade, earnings revisions have drifted lower.
However, Mag7 companies have been more resilient with respect to fundamentals than their index peers. Specifically, Mag7 companies are now expected to contribute ~50% of 2025 S&P 500 earnings growth despite representing just 25% of overall S&P 500 earnings and 31% of S&P 500 market cap.
There is a reason that these companies have dominated the better part of the last decade: They’ve contributed the lion’s share of earnings growth. Until this fact changes, there is no reason to believe they will not continue to outperform. I believe they are set to continue this trend due to their heavy investment in the next breakthrough technology: AI.
Wrapping Up
Periods of volatility are excellent opportunities to add to high-conviction names that go on sale. It is also a time when you need to rethink your thesis from a first-principle perspective. Does the short-term noise change in any way the long-term picture? It shouldn’t. But you should also ingest new information to be open and adaptable to change.
For example, I don’t think all this tariff noise affects the momentum of artificial intelligence in a meaningful way. However, export bans and higher tariffs do force physical supply chains to reorganize, which will change the semiconductor business. Tariffs also throw uncertainty into the mix, causing businesses to take a “wait and see” approach for budget allocation.
Over the long term, one dude turning off and on tariffs like a light switch will not stop the progress of artificial intelligence.
While we’re far from getting out of the woods, it looks like there’s a path through the trees.
Strong convictions, loosely held.
— Nick Mersch, CFA
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