The three-year AI super-cycle story may be quietly changing gears. In a recent podcast discussion, three senior Goldman Sachs figures concluded that peak growth in AI capital spending is close at hand, and that the market's pricing of the AI theme has shifted from one-sided optimism focused only on the upside to a two-sided debate that weighs both good and bad outcomes. At the same time, the Federal Reserve's actual rate hikes are likely to fall short of what the market is currently pricing in.
In the October 29 episode of "The Breaks of the Game," Tony Pasquariello, Goldman Sachs' global head of hedge fund coverage, Josh Schiffrin, the firm's global head of risk, and Dominic Wilson, a senior adviser in Goldman Sachs Research, conducted a systematic review of the evolution of the AI capital spending narrative, the Fed's path and the wall of macro risks just after a heavy week of Big Tech earnings. Wilson said plainly that AI has moved from a "supercharged theme" to a "more conventional narrative," and that peak growth rates are "probably quite close."
The backdrop for that view is that the S&P 500 has essentially gone nowhere over the past six months, and the Nasdaq has done the same. Pasquariello noted that this earnings season has been "okay on the surface," but forward earnings revisions have fallen far short of the upgrades seen in the first and second quarters, adding that the results were "enough to hold the line, but not enough to ignite another breakout."
Meanwhile, Schiffrin identified an escalation in the Middle East as the biggest near-term growth risk and named "long global front-end rates" as his highest-conviction trade into year-end.
AI turns from a super theme into a two-way story
When a theme is priced for the most optimistic path, even a small piece of disappointing information can amplify the negative impact. Goldman Sachs' judgment is that AI infrastructure investment is at a tipping point.
The AI trade reaching this stage is the result of three threads emerging at once. First, market prices already embed very optimistic expectations. Second, peak investment growth is approaching. Third, the credit demand financing this wave of investment is starting to leave traces in the market. Together, these three factors have turned the theme from "just believe" into "do the math" — faith alone is no longer enough; you have to look at financing, earnings and whether rates can hold up.
In the program, Wilson broke down the argument, noting that since the "bubble-like peak" in AI-related sectors last June, the bank has worried that the market has overpriced the entire AI space. "Not that the pricing is absurd, but it is at a level that requires a fairly optimistic path to support current prices, especially in infrastructure," he said.
The data from Big Tech earnings season is no longer one-sided information. In Wilson's words: "What you see on the earnings side is a scatter plot. Our own forecasts suggest the peak in the investment impulse is probably not too far away. Growth will continue, but peak growth rates are probably quite close."
He further listed three specific cracks, including questions about financing and monetization. First, credit spread pressure from Big Tech's credit financing needs is "intermittent, but there is indeed some underperformance." Second, there are "still question marks" over Big Tech's monetization path. Third, earnings performance has diverged rather than moving in lockstep as before. Still, Dominic was talking about peak growth rates, not saying the absolute scale of capital spending would decline.
Wilson's conclusion: "Once you are facing this kind of situation — peak growth in the main story, rising rates, wider credit spreads — it feels like a more conventional narrative. It used to be a supercharged theme that lasted about three years. Now the risk balance is more two-sided, and the story is more conventional."
Earnings propped up the index but could not push it higher
Over the past six months, the logic driving U.S. stocks has been a tug of war: rates, energy and to some extent credit acted as headwinds, while corporate earnings provided support. The result was no net movement in the index. The problem with earnings season was not that results were bad, but that they were "just enough": companies cleared the bar, but the pace of upward revisions was not enough to push the market to a fresh breakout.
This is where the market is most anxious right now. During the second-quarter earnings period, investors realized this year could be one of unusually strong earnings growth, and expectations were revised up sharply. This earnings season has not repeated that effect. Tony said: "The S&P is basically back at 7,000... and the Nasdaq has not really moved in any direction over the past six months."
"For this quarter, earnings look okay on the surface. The bar is high... I think the most interesting thing is that forward earnings have not been revised up the way they were during the first- and second-quarter earnings periods."
In his view, full-year earnings growth will ultimately be impressive, possibly close to 30% or even higher (according to the transcript, the wording at this point was not entirely clear, and the audio should be checked before publication). But this year's numbers have largely been digested by the market. Tony's summary: "Good enough to hold the line, but not enough to add fuel for another breakout."
Fed: markets have priced in too much, and actual hikes may stop here
As the AI narrative cools, uncertainty over the rate path forms another main thread. Schiffrin's read of the Fed's October meeting was broadly dovish, and he clearly believes the market is overestimating the current pace of rate hikes.
Schiffrin's judgment is that the Fed believes it has the ability to "act in an orderly way." Although inflation remains severe, the September policy action is already having an effect, and financial conditions, while not extremely tight, have tightened somewhat. His base case is one more hike in December, perhaps another after that, but "the ultimate number of hikes is likely to be less than the market currently expects."
In his words: "You now have about 60 to 65 basis points of further hikes priced in. I do think they will hike in December, but that is probably it. Maybe one more. But my base case, as we discussed last month, is one more in December."
Schiffrin also noted that starting in 2027 and 2028, the Fed will reduce the frequency of policy statements from eight meetings a year to seven, but he does not think this will have a major market impact: "Some meetings are already very close together, and not much happens between them, so I do not think this will have a big effect on the market."
Wilson's judgment on rates is highly consistent with Schiffrin's. He noted that part of the earlier rise in rates was because the 10-year forward OIS rate briefly touched around 5.20%. "That is already very close to the peak of the policy rate cycle over the past 20 years. If you use that as your midpoint 10 years out, then you have already built in a fair amount of risk premium," he said. He believes the wobble in the AI narrative is also pushing yields lower through the "growth concerns" channel.
Macro risk wall: the biggest threat comes from the Middle East, while the most underpriced risk is lower oil prices
In ranking macro risks, an interesting divergence and complement emerged among the three speakers: Schiffrin listed an escalation in the Middle East as the biggest near-term risk, while Wilson argued that the tail risk of oil prices "not escalating" is in fact the opportunity the market is most underpricing right now.
Schiffrin's logic is direct: if the conflict escalates and energy prices rise again, that is the biggest growth threat; conversely, if the situation eases and oil prices fall, "that is good for assets overall, both equities and bonds."
Wilson approached it from another angle. He believes the market has already built up a considerable risk premium for Iran geopolitical risk, and there is a real risk premium in the oil market. Therefore, "the part where we simply do not follow through, or the escalation is less than the market fears, I think is underpriced." His specific scenario: if there is no major escalation within two or three weeks after the midterm elections, "the market will find that this is a better path than it feared, because we have already built in that expectation. Even without any substantive progress, simply the absence of new bad news would be enough."
On the highest-conviction trade into year-end, Schiffrin pointed clearly to "long global front-end rates" across the United States, Europe and the United Kingdom, on the grounds that major central banks will act less than the market has priced in, and that any volatility in credit markets would also provide a downward channel for front-end rates.
Tony Pasquariello offered a summary description of the overall market backdrop: over the past six months, rates, energy and credit at the macro level have acted as headwinds, while earnings have "held the line." The S&P 500 and Nasdaq have essentially gone nowhere. This earnings season has been "okay on the surface," but forward earnings revisions have been far weaker than in the first and second quarters, "enough to hold the line, but not enough to ignite another breakout." His conclusion: if Schiffrin and Wilson are right, stocks may enjoy a "nice glide path" into year-end, but leadership may come from "different types of stocks."
Comments