For a stock market being priced for AI perfection, developments from OpenAI are raising concerns…
The company behind ChatGPT missed internal projections for user growth and revenue targets, according to a report from The Wall Street Journal.
The company’s executives are also worrying about the massive computing agreements it’s making, and if revenue growth can justify the expenditures.
While OpenAI pushed back against the report, it’s not the first time that investor concerns have emerged over the sums being plowed into AI infrastructure… and whether the payoff is worth the expense.
That has important implications for the entire stock market, where the recent rally is being supported by optimism for AI earnings.
AI-linked stocks and the technology sector are playing a key role in boosting the entire stock market as financial projections are being revised higher… but rosy expectations could come back to bite investors.
The rally in the S&P 500 is being driven by a rebound in earnings estimates looking ahead. That’s a deviation from the trend normally seen.
Typically, analysts are too optimistic for calendar year earnings early on, with profit estimates for the S&P 500 drifting lower through the year.
That hasn’t been the case this time around. Earnings have been revised higher by about 4% since January.
But optimism in just a handful of AI stocks is behind the bulk of the revisions. In fact, one estimate from Goldman Sachs pegs nearly 70% of the positive revision to just four companies leveraged to the AI infrastructure buildout.
Chip company Micron (MU) alone accounts for half of the revision. Meanwhile, eight of the S&P’s 11 sectors have seen no increase in EPS estimates.
Enthusiasm over AI’s impact is a key catalyst in boosting the earnings outlook, and it’s showing up in other financial metrics as well.
But that’s leaving stocks priced for perfection, where any slip-up in financial forecasts could weigh the entire stock market.
AI-driven earnings revisions are playing a big role in the S&P 500’s quick rebound off the late March lows.
The earnings outlook is being driven by rising net profit margins, or how much companies keep in profits as a percentage of their sales.
The jump in profit margins is historic. So far, the blended net profit margin for the S&P 500 is 13.4%. If that result holds, it will mark the highest net profit margin for the S&P 500 in history.
Over the next four quarters, profit margins are projected to jump higher still, with the fourth quarter forecasted to reach 14.6%, as you can see in the chart below. That means earnings revisions and profit margin forecasts are moving higher at the same time.
S&P 500 Net Profit Margin
Source: FactSet
The tech sector is a major driver of the outlook, with a first-quarter profit margin running at 29.2% compared to the five-year average of 25.3%, according to FactSet.
That shows the recent rally in the stock market to new record highs is being driven by optimism around the AI profit outlook… which is leaving investors vulnerable at the same time.
Any risk of disappointment in achieving the rosy projections could lead to a fast repricing of AI stocks, which continue to dominate major market indexes like the S&P 500 and Nasdaq.
OpenAI is reportedly facing slowing growth.
Any signs of trouble among the AI hyperscalers reporting earnings this week could lead investors to quickly rethink the profit outlook… and remove a key catalyst behind the rally.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
