'We're going to have to be navigating these nuances as they come': Chronert

Key Concepts

Pullback: A temporary decline in stock prices after a period of strong gains.
Lofty Expectations: High anticipated performance or growth for companies, often driven by future trends like AI.
AI Playbook: Strategies and investments focused on Artificial Intelligence technologies and their potential.
Q3 Reporting Period: The third quarter of the fiscal year, during which companies release their financial results.
Valuations: The process of determining the current worth of an asset or company.
Implied Growth Characteristics: Future growth potential of a stock as suggested by its current market price and financial data.
Incremental News Flow: New information or developments that influence stock prices.
Revenue Forecasts: Predictions of future income for a company.
Fundamental Tailwind: A strong underlying economic or technological force that supports growth.
Excess of Supply: When demand for a product or service outstrips its availability.
Earnings Season: The period when companies report their quarterly financial results.
Earnings Beat: When a company's reported earnings exceed analysts' expectations.
Estimate Revisions: Adjustments made by analysts to their future earnings predictions for a company.
Outyear Growth Expectations: Anticipated earnings growth for future years beyond the current reporting period.
Reluctant Bulls: Investors who are participating in the market and seeing gains but remain cautious or concerned about potential risks.
Positioning Perspective: How investors are allocating their capital and their overall exposure to the market.
Sentiment Indicators: Metrics that gauge the overall mood or attitude of investors towards the market.
Bubble Phrase: A term used to describe a market or asset that is perceived to be overvalued and at risk of a significant decline.
Broadening Construct: A market trend where gains are spread across a wider range of stocks and sectors, rather than being concentrated in a few.
US Small Mid-Cap: Stocks of companies with smaller to medium market capitalizations in the United States.

Summary

Current Market Weakness and AI Expectations

Scott Kroner, US Equity Strategist at Citi, discusses the recent weakness in US stocks, which has also impacted the Canadian market. He characterizes this as a "blip" or "pullback" following a period of strong performance since the April lows. The primary driver for this pullback is attributed to "lofty expectations" for the Q3 reporting period, both in terms of valuations and implied growth characteristics of stocks. Kroner suggests that expectations have been stretched so far that incremental news flow is struggling to support stock prices in the short term. However, he emphasizes that this does not signify the end of the "AI playbook" but rather a period of pause.

AI Spending and Justification

The conversation touches upon the ambitious revenue forecasts for AI, with OpenAI's projected $1 trillion spending over the next decade being a notable example. Kroner explains that such significant spending provides a "fundamental tailwind" for companies involved in AI. However, it also raises the question of "when is enough too much?" and whether incremental investments become difficult to justify. While the underlying demand for AI strategies appears to be in "excess of supply," suggesting a continued tailwind, navigating these nuances will be crucial.

Formula for Success in Earnings Season

Kroner outlines the key factors that have defined a successful reporting period in the US. It's not just about achieving a Q3 earnings beat; companies also need to see their Q4 estimates and, more importantly, their 2026 full-year estimates revised higher. This is because the market is looking beyond current results and focusing on future growth expectations. The "formula for success" has been to demonstrate an "ongoing upward trajectory in outyear growth expectations," which has been a significant differentiator across large-cap, small-cap, and mid-cap stocks.

The "Reluctant Bull" Phenomenon

Kroner elaborates on the concept of "reluctant bulls." He observes that investors, both professional and retail, are actively participating in the market due to its strong performance since the April lows. This is reflected in high equity allocations compared to historical averages. However, sentiment indicators reveal a different picture, with ongoing concerns about spending trajectories and the potential for a "bubble." Kroner frames this as investors being "in the market" with "valuation concerns," leading to a more "middle of the road" sentiment.

The "reluctant bull" concept has two responses:

Bullish Response: Incremental positive news, especially when pushing outyear expectations higher, is rewarded. This was evident during the Q3 reporting season.
Not So Bullish/Bearish Response: Any "noise" or negative developments in this "perfect setup" triggers selling. This is what Kroner believes is contributing to the current week's market weakness.

Outlook for 2026 and Broadening Market Participation

Looking ahead to 2026, Kroner anticipates that the market's performance will be more aligned with earnings growth trends rather than significant valuation improvements, given the current starting valuations in the US market. The focus will be on the persistence of the earnings growth tailwind into 2027 and beyond. He believes there is a strong prospect for earnings acceleration more broadly in the coming year.

Furthermore, Kroner sees a "catch-up growth opportunity" for US small and mid-cap stocks, as well as for international markets. This "broadening construct" suggests that new money may flow into areas that have not participated to the same degree in recent years. While the AI playbook is expected to continue, there's a compelling argument for diversifying investments into these other segments.