Chapter 50: An Earnings Inflection Point
Dear Clients,
Quarter two of 2025 marked an inflection point in the company earnings of some of our major holdings. That AI is ushering in a new era of disinflationary productivity-led gains was evident in two of our major holdings, Microsoft (up 4%) and META (up 11%) on their earnings releases, in a single day. These earnings releases were more than a positive surprise. They marked a fundamental turning point in the productization of AI, whose use cases have now expanded beyond content creation to end-to-end automation of an advertising campaigns, agentic AI – which are automated bots equipped with decision making ability capable of front-line client service activities – and productivity enhancements across a wide spectrum of industries stemming from enhanced efficiencies. Hard dollars are backing up our earnings-driven investment thesis, which we will remind clients has always been based on secular, disinflationary growth. META generated a positive earnings surprise of 21%, while MSFT’s Azure growth came in 500 basis points higher than consensus expectations, marking a new cycle of adoption and acceleration. Each company is expected to invest between $85 to $95bn (USD) in capital expenditures in 2026, most of which will go to data centers and technical infrastructure supporting AI-driven productivity gains and a return on invested capital (ROIC).
Herein lies an important point: That these earnings inflections can exist is contrary to the notion of efficient markets, which theorizes that share prices capture all available information – either strong form (completely) or weak form (partially) – nullifying an investor’s interpretational advantage. The efficient markets hypothesis, unfortunately, is built on the notion that price fluctuations / volatility are equal to risk; whereas we define risk as the companies’ underlying business and financial vulnerabilities, requiring deep due diligence into their threats, opportunities, and business models. This is also one of the pitfalls of measuring portfolio performance on tracking error – which represents the standard deviation relative to the benchmark in terms of price returns – whereas a more nuanced approach would measure the deviation in earnings quality within the confines of a long-term secular trend, as we track every quarter with our investment scorecards.
In our last installment, we highlighted the disparity between the resilient hard economic data and the softening confidence data resulting from the enactment of tariffs. We further presented our base case thinking that tariffs were being used as a negotiating stance to lower worldwide trade barriers and strike trade deals. As we presented in that installment, “trade wars were turning into trade deals” (words of Dr. Ed Yardeni) contributing to the improved markets backdrop. On top of that, we continue to remain fully invested in an earnings-driven bull market, wherein 2025 year-end earnings per share (EPS) is continually being revised higher. At our S&P 500 EPS target of $300/share, we are targeting further earnings driven upside into the year-end, notwithstanding periodic volatility and fluctuation owing to the surprise-driven nature of markets. As a reminder to clients, markets and their underlying companies are valued on the annuity-producing hard economic data, versus soft confidence data that tends to fluctuate and be fleeting.
In conclusion, notwithstanding the short-run economic volatility or geopolitical, event-driven surprises, this earnings season represented an inflection in the widespread adoption and use cases of AI. That large-cap behemoths can jump by 4-11% in a single day is testament to the inefficiency of the market – even the large cap S&P 500 – where it is widely perceived that all available information has been captured into the price. Furthermore, with our macro-led investment thesis that tariffs were used as a bargaining position to lower worldwide trade barriers, we have now seen the secular bull market resume, predicated on upwardly biased earnings estimates and secular earnings growth.
We hope clients have found this installment helpful.
Warmest regards,
Grace Wang | Senior Portfolio Manager
Samuel Jang, CFA | Investment Associate
Leslie Mah | Associate Advisor
Katherine Yang | Associate
Steven Bos | Administrative Assistant
Grace Wang Portfolio Management Practice of RBC Dominion Securities
Email: gracewangpractice@rbc.com
Phone: 604-257-2483
745 Thurlow Street, 20th Floor
Vancouver BC, V6E 0C5
gracewangpractice.com
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