Back to the Future: A Market of Contradictions
Today, October 21st, marks “Back to the Future Day,” commemorating the date to which Marty McFly, famously played by actor Michael J. Fox, traveled in the 1989 film Back to the Future Part II. Although the year in the DeLorean’s computer was set to 2015, included among the movie’s many prognostications were recreational hoverboards, self-tying sneakers, flying cars, and a Chicago Cubs World Series championship. While some of those predictions were better than others, Elon Musk brought us a little closer to the flying car last week when Tesla unveiled a new Roadster prototype capable of briefly taking flight using technology developed with SpaceX.
Nearly four decades after the movie’s release, predicting the future remains a tricky business, yet investors are tasked with it on a daily basis. Stock prices reflect expectations of future earnings, economic conditions, technological developments, and countless other variables that are inherently difficult to predict. As we move further into third-quarter earnings season, the prospect of meaningfully above-average earnings growth in the face of a mixed economic backdrop highlights both the resilience of corporate America and the challenges investors face in assessing the road ahead.
Earnings at 88 Miles per Hour
Through Friday, just 9% of the S&P 500 companies had reported third-quarter results, setting the stage for an additional 50% of constituents to report earnings this week and next. Currently, quarterly earnings are projected to grow an astounding 29% year over year, potentially marking the third consecutive quarter of growth exceeding 25%. This compares favorably to historical S&P 500 annual compound earnings growth of approximately 7% over the past half-century. It’s worth noting that the current earnings strength isn’t exclusively an AI story. Ten of eleven sectors are expected to post positive earnings growth in Q3, although Technology, Communication Services, and Energy remain the most important contributors.
Stepping back, corporate profitability has generally benefited from pricing power, operating efficiency, and continued technology investment. However, increasing energy, labor, and financing costs raise the question of how sustainable today’s margins will be. Corporate results over the next few weeks should help determine whether the anticipated strong 2026 results can support investor expectations for 2027. Moreover, while so much attention has been centered on the “Magnificent 7” in recent years, we’d point out that earnings growth for the “Other 493” (within the S&P 500) is catching up with that of the Magnificent 7, with expected growth of 28% for Q3. Furthermore, an early look at fourth-quarter estimates shows expected year-over-year earnings growth of 31% for the Other 493, outpacing 24% growth for the Magnificent 7. We believe evidence of broadening earnings growth is a feature of a healthy market, providing greater scope for stock selection to add value while creating diversification opportunities across economic sectors.
Great Scott! Midterms and Affordability
As political ads from both sides of the aisle continue to pummel the general population over the next two weeks, one critical election issue is the persistent rise in the cost of living and policymakers’ difficulty reining in inflation. Alongside above-trend economic growth since the pandemic, inflation has remained stubbornly elevated, in part due to the trade war tariffs and the war in Iran. These policy decisions, while initially creating uncertainty for business and financial markets, have increasingly drawn the attention of consumers and political strategists alike because of their impact on affordability. Recent poll results suggest that elevated, persistent inflation is a primary concern for voters and will undoubtedly impact election results.
Demographic factors seem likely to play a critical role in the midterm elections as well, as older, wealthier, asset-owning households have benefited disproportionately from appreciating financial assets, while younger households face rising housing and living costs. According to a recent Wall Street Journal analysis of 2025 household financial data, median family net worth increased just 2% in real terms between 2022 and 2025, while households headed by people 75 years or older experienced roughly 37% growth and those headed by people under 35 years old suffered declines exceeding 20%. A household benefiting from a rising stock portfolio and a low fixed-rate mortgage is living in a different economy from a young family trying to buy its first home.
Housing Is Stuck in the Past
Per the National Association of Realtors, the median age of first-time homebuyers was 40 in 2025, up from 31 in 2015. First-time buyers also made up just 21% of total buyers, a record low. Higher home prices and mortgage rates have combined to severely reduce activity for two main reasons: existing homeowners are likely reluctant to give up their ultra-low mortgage rates from years ago, while a 7.4% interest rate on a 30-year fixed loan is a non-starter for many younger Millennial and Gen Z prospects.
The result is a challenging, low-transaction, low-turnover environment, which is clearly observable in the data. In September, the pending home sales index fell 7.3% month over month and 11.3% year over year to 66, its lowest reading since the series began in 2001. Existing-home sales did rise 1.5% from August, but their annualized pace of 3.99 million remained below 4 million for a second straight month and was down 2.2% from a year earlier. The National Association of Home Builders (NAHB) Homebuilder Sentiment Index fell to 29 in October, its lowest reading since June 2012. Buyer traffic is at similarly depressed levels. Single-family permits, a leading indicator, fell 4.0% in September to an annualized 845,000, their lowest level since March 2023 and 4.8% below a year earlier. Finally, builders are increasingly relying on incentives to move inventory. In October, 43% reported cutting prices, and 65% offered sales incentives, according to the NAHB.
This has implications well beyond homebuilders. Housing-related activity accounted for 15.8% of GDP in the second quarter, including a more cyclical 3.7% directly from homebuilding and remodeling. Weak construction and turnover also dampen mortgage and brokerage activity, moving-related purchases, and spending on furniture and appliances, creating a drag on consumer spending. With other parts of the economy driving growth, housing’s prolonged slump is a meaningful counterweight. Longer term, poor affordability is also a drag on household formation. Harvard’s Joint Center for Housing Studies recently reported that household growth slowed from a 2.0 million pace in 2021 to 1.1 million in 2025, with housing costs among the pressures keeping more young adults from forming independent households.
Why Diversify? The Future Is Rarely a Straight Line
There is no debate that AI-related investment has been a major positive contributor to economic growth, corporate earnings, and equity market performance. We agree that the underlying technological opportunity appears substantial, but expectations have also become increasingly demanding, capital needs have ballooned, and financial conditions have recently become somewhat less favorable. That is why diversification still matters across sectors and across asset classes. Smaller and mid-sized companies, international stocks, and value-oriented businesses respond to different forces than the market’s largest technology companies. Owning them does not mean betting against AI. It means recognizing that today’s leaders may not be tomorrow’s.
The lesson for investors isn’t that the future looks particularly ominous. It is that the future rarely unfolds precisely as anticipated. Successful long-term investing requires participating in tomorrow’s opportunities without becoming overly dependent on any single prediction about how we get there. Over the coming few weeks, corporate earnings and the Federal Reserve’s upcoming policy decision should provide investors with additional clues about the direction of the economy and financial markets. Strong and increasingly widespread earnings growth remains an encouraging foundation, but persistent inflation, elevated financing costs, and uneven economic conditions pose risks.
Birthdays:
Kim Kardashian, media mogul and entrepreneur, turns 46 today, while Judge Judy Sheindlin celebrates 84 years, and Steve Lukather, Toto’s guitarist and founding member, rocks out at 69.
Shawn Gallagher, CFA® 610-260-2211