US stocks have room to run, but be selective

THE US economy continues to defy expectations of a meaningful slowdown.

Real gross domestic product expanded by 1.5 per cent in the second quarter of 2026, while the Federal Reserve Bank of Atlanta’s GDPNow model, a running estimate of real-time GDP growth, pointed to growth accelerating to 4.7 per cent in Q3.

Importantly for investors, corporate earnings remain exceptionally strong. S&P 500 earnings grew 52 per cent year on year in Q2, said FactSet, accelerating sharply from 29 per cent in the first quarter.

Energy and technology led the charge. Higher oil prices supported 146 per cent earnings growth in energy, while strong semiconductor demand helped drive 77 per cent growth in the information technology sector.

This is not simply a story of a handful of mega-cap companies carrying the market. Ten of the S&P 500’s 11 sectors reported year-on-year earnings growth. Healthcare was the exception, declining 6 per cent. Ten sectors also beat consensus earnings estimates.

The weakness in healthcare was also less broad-based than the headline figure suggested.

Gilead Sciences and Merck accounted for much of the weakness, with significant charges distorting reported earnings. Excluding these two companies, healthcare earnings would have risen 18 per cent.

Admittedly, headline earnings growth does overstate the underlying picture to some extent.

Alphabet and Amazon benefited from substantial unrealised gains on investments, such as Anthropic, producing extraordinary year-on-year earnings growth of 294 per cent and 242 per cent, respectively.

Even after stripping out these two companies, however, S&P 500 earnings growth would still have been a robust 34 per cent.

This earnings strength has also been reflected in markets, with the S&P 500 up 12.5 per cent in the year to Sep 4. The question now is where the next leg of earnings growth will come from.

AI’s next winners

The artificial intelligence boom remains one of the most powerful growth engines in the market.

Hyperscaler capital expenditure by Meta, Alphabet, Amazon and Microsoft is projected to reach US$760 billion in 2026, 85 per cent higher than last year, with further increases signalled into 2027.

But there is a limit to how quickly spending can keep rising. As AI infrastructure investment weighs increasingly heavily on free cash flow, we expect the pace to moderate from 2028.

That does not mean the AI investment cycle is ending. Rather, it suggests that investors should broaden their exposure.

The first phase of the boom was dominated by companies supplying the physical infrastructure. During the next phase, a greater share of the economic benefits could flow to companies that actually monetise AI.

Within semiconductors, we remain neutral on US names, and continue to see greater value in Asian semiconductor companies, where valuations are more attractive.

We are more constructive on Internet companies, where AI monetisation is increasingly moving from promise to proof.

Cloud order backlogs at Amazon, Alphabet and Microsoft have grown 149 per cent year on year, suggesting that demand is increasingly backed by contracted business rather than speculation.

Meta, meanwhile, has begun monetising AI directly through subscriptions and paid business agents.

As infrastructure spending eventually peaks, a greater share of the economic benefits from AI should flow towards software and services, where margins are typically higher.

At the same time, rising capital expenditure has weighed on sentiment towards Internet companies, leaving valuations more attractive relative to their growth prospects.

The consumer: not breaking but losing momentum

We are more cautious on consumer discretionary stocks, where headline earnings growth of 93 per cent looks considerably stronger than the underlying picture.

Amazon was by far the largest contributor, helped by a US$53.4 billion gain primarily related to its investment in Anthropic. Excluding Amazon, sector earnings growth falls to just 9 per cent.

More importantly, Amazon is hardly a pure consumer discretionary company. Its cloud business gives it substantial exposure to the same AI investment cycle driving technology earnings.

Away from the accounting distortions, there are signs that US consumption is losing momentum. Inflation-adjusted consumer spending was flat month on month in July, while the consumer confidence index fell to 89.4 in August from 90.2 in July, its lowest level since January.

McKinsey’s ConsumerWise research pointed in the same direction, with more consumers planning to spend less across most discretionary categories over the next three months.

This comes as inflation remains stubbornly elevated. July personal consuption expenditures (PCE) inflation held at 3.7 per cent year on year, while core PCE remained at 3.3 per cent, both more than the US Federal Reserve’s 2 per cent target.

Inflation has stalled rather than continued its earlier decline, while energy, food, semiconductor costs and tariffs present additional upside risks.

For households, persistently high prices are eroding purchasing power.

Real average hourly earnings declined 0.1 per cent year on year in July, while real disposable personal income grew by only 0.5 per cent. The boost from unusually high tax refunds earlier this year is also likely to fade as most refunds have now been paid out.

Higher-for-longer interest rates add another layer of pressure.

If inflation fails to move towards the Fed’s 2 per cent target quickly enough, further rate hikes remain a possibility, particularly hurting big-ticket purchases.

Home Depot and Lowe’s continue to flag weak demand for large-scale home improvement projects, as elevated borrowing costs make such spending harder to justify.

Still, we do not expect US consumption to collapse. A stable labour market and continued spending by higher-income households should provide an important buffer. The more likely outcome is a moderation from the unusually strong pace seen in the first half of 2026.

Quality matters

This backdrop also warrants greater caution towards loss-making companies. Higher-for-longer rates raise funding costs, while putting greater pressure on the valuations of businesses that have yet to generate consistent profits.

We therefore favour quality companies with strong balance sheets, consistent earnings and high returns on equity.

These businesses are better equipped to absorb elevated borrowing costs and navigate a more challenging macroeconomic environment, without relying on ever-easier financial conditions.

Ultimately, strong earnings continue to lift US equities as a whole. But, investors will need to be increasingly selective about where they put their money.

The writer is a research analyst with the research and portfolio management team at FSM Global, the B2C division of iFast Financial, the Singapore subsidiary of iFast Corporation