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Revisiting the Reflexive Economy… what we got right, and where it stands today… what Louis Navellier expects from earnings … why the real risk isn’t the lower-K consumer… what to watch as Q3 earnings season kicks off
Last November, I asked Digest readers a question:
What if the economy wasn’t being lifted by paychecks anymore – but instead, by brokerage statements?
As I spelled it out then, thanks to the “wealth effect,” Americans who own stocks feel richer when their portfolios climb, so they spend more on restaurant meals, business-class tickets, and home renovations. And since the top 10% of earners accounted for nearly half of U.S. consumer spending in 2025 – the highest share on record – that wealth-driven spending had become a major engine of economic growth.
I called it a “Reflexive Economy.” Rising stock prices boost economic confidence, which fuels spending, which supports earnings, which in turn support stock prices. It works beautifully on the way up, but it can be a nightmare on the way down.
One of the takeaways from that Digest, courtesy of our hypergrowth expert Luke Lango, editor of , was that earnings were the key to the bull market – far more so than the elevated valuations that the financial media had been worrying about.
That was 11 months ago. As we stand here today, Q3 earnings season kicks off tomorrow, and we’re just a day removed from fresh all-time highs in the S&P 500 and the Nasdaq. So, it’s a good time to revisit that Digest.
What’s changed, and where does it leave us today?
What we said versus what happened
Let’s start with earnings…
In that November Digest, we shared FactSet’s projections of 11.8% earnings growth for the S&P 500 in Q1 2026 and 12.7% in Q2.
What actually happened?
Well, Q1 came in at about 29%, and Q2 at about 52%. That blew the doors off the forecasts and was the highest growth rate since Q2 2021. Even setting aside some large one-time investment gains at Alphabet (GOOGL) and Amazon (AMZN), growth roughly doubled what analysts expected.
So, earnings not only held up – they blew past expectations. And as Luke predicted, the bull market charged on.
Now, let’s turn to the rest of the economy…
Regular Digest readers know we often describe today’s economy as “K-shaped.” The upper spoke of the K represents Americans with significant assets, such as stocks and real estate, whose wealth has been rising. The lower spoke represents Americans who depend mainly on their paychecks, and who’ve been struggling as prices outpace wages.
Since November, that lower spoke of the “K” has taken a beating. The Iran conflict has triggered an oil shock, with gasoline prices up 27% from a year ago.
Meanwhile, rather than cutting rates, the Fed raised rates in September, lifting the prime rate from 6.75% to 7.00%, its first increase since July 2023. That matters because the prime rate drives borrowing costs on credit cards and many other consumer loans. More pressure on Main Street budgets.
Turning to wages, while they’re up 3% from a year ago according to the BLS, that’s still below the current rate of inflation, which is running at 3.4% per last week’s PCE report. Meanwhile, last Friday’s unemployment data showed just 29,000 jobs added in September.
Unsurprisingly, consumer sentiment has cratered. The University of Michigan’s index fell to a record low of 44.8 in May and was still just 48.1 in September.
Now, despite all those pressures, consumer spending climbed 0.6% in August – even after adjusting for inflation. But that spending is increasingly narrow. Lower-K Americans are still spending enormous sums, but mostly on necessities like gas, groceries, and rent.
It’s the upper spoke – the Americans who own assets – that’s driving spending growth, especially on discretionary purchases that keep the economy moving.
And, since healthy upper-K spending ties to stock values, which are anchored in earnings, let’s preview the Q3 earnings season that’s about to start.
“Another stunning quarterly earnings announcement season”
If upper-K spending depends on stock prices, and stock prices depend on earnings, how sturdy is that support as we eye Q3 earnings?
On the surface, it could hardly look better.
Here’s legendary investor Louis Navellier, editor of , from yesterday’s October issue:
I’m most excited about the upcoming earnings season. Analysts have been raising third-quarter earnings estimates, setting the stage for another stunning quarterly earnings announcement season.
FactSet currently estimates that the S&P 500 will achieve 29.5% average earnings growth in the third quarter. Given positive analyst revisions and the propensity for wave after wave of positive earnings surprises, I suspect the S&P 500 will achieve average earnings growth north of 33%.
Louis’ point about rising estimates deserves emphasis, because it’s unusual. Over the past five years, earnings expectations have fallen by 2.2% on average during a quarter. This time, they rose by 1.4%.
But for our purposes, the more important question isn’t how much earnings are growing. It’s where that growth is coming from. Back to Louis:
Energy-related stocks and AI- and data center-related stocks continue to garner the most attention.
The information technology sector is expected to post the second-highest earnings growth rate of all the 11 S&P 500 sectors. FactSet currently expects it to post 65% average earnings growth.
The energy sector, on the other hand, is expected to report the highest earnings growth rate…
FactSet currently estimates the energy sector will achieve 114% average earnings growth due to higher oil prices and increased demand.
Two consumers, two markets
Now, let’s be clear – the energy boom is largely a war premium, funded in part by the $4 gasoline that lower-K Americans pay at the pump. The durable growth engine is AI.
Meanwhile, the sectors most tied to everyday spending are lagging. Consumer Staples earnings are expected to grow just 2.9%, down from 6.4% expected back on June 30, and Walmart, where lower-income shoppers have been pulling back, has been the biggest drag on those estimates.
So, just as there are two consumers, there are two markets. Luke calls it the “AI Bifurcation.”
Here he is from his Daily Notes earlier this week:
A narrow rally is not a weak rally — it’s the AI Bifurcation reasserting itself…
With rates still elevated and fuel costs pressuring the broader economy, the parts of the market that can generate earnings growth fast enough to outrun higher discount rates are the ones attracting capital, and right now that’s overwhelmingly the AI complex.
Broad, everything-up rallies typically require a decisive macro catalyst like falling rates or a geopolitical resolution. Until that arrives, we’d expect leadership to stay narrow and concentrated in AI.
So, let’s put it all together now…
AI – largely powered by Big Tech spending – is powering the market’s earnings growth. And that’s attracting capital, which is lifting tech stocks and making upper-K Americans feel richer, who then spend more. This is where spending growth is coming from.
Squeezed lower-K households still account for enormous spending, but those dollars are largely maintaining the consumer-staples economy – not growing it.
The takeaway is that the economy’s broader growth story now has a single primary driver: AI earnings.
Does this mean everything hinges on AI we should limit our AI exposure?
Kind of…and no.
In November, we walked through how the wealth effect could reverse. Here’s the updated version, now with a single trigger:
- AI earnings or guidance disappoint
- The AI complex reprices lower, dragging down the broader indexes it now dominates
- Upper-K portfolios shrink, and so does their spending
- Consumer-facing earnings crack last
First, notice what’s missing from the top of that list: the struggling lower-K consumer.
That’s because Big Tech spending is what’s driving AI earnings – not lower-K household budgets. So, their current economic pain is real, but it’s more likely to be a lagging indicator than one of the straws that break the camel’s back.
This has a counterintuitive implication for any investors nervous about their tech stocks at or near all-time highs today…
On one hand – yes – this market is increasingly dependent on AI, which, understandably, fuels many investors’ instinct to “diversify” by rotating money out of AI and into consumer stocks. But in a single-engine economy, those companies sit downstream of the same wealth effect. So, if AI stumbles, they’re likely to stumble too.
That’s one reason Luke keeps emphasizing focus over diversification right now. When the whole system runs on one engine, spreading your money around buys less protection than you might think, while limiting your potential upside.
What protects you is knowing your investment goals and temperament – and having a written plan with exits tailored to you, including the earnings signal we’ll turn to next.
The main signal to watch this earnings season
As Louis noted, expectations heading into this season are sky-high, with the tech sector expected to grow earnings by 65%. That’s terrific if companies deliver. But high expectations cut both ways.
When the bar is this high, even a strong quarter can disappoint if management’s outlook for the months ahead falls short of what Wall Street has penciled in. That’s why the number to watch isn’t whether companies beat – it’s what happens to forward earnings estimates.
Last November, Luke told us that valuations didn’t end the dot-com boom; falling earnings estimates did. So, as long as estimates for tech and AI keep rising, the engine is running – and right now, they’re rising.
Here’s Luke on why he believes AI stocks are on the launchpad:
Tech-sector EPS is projected to rise from roughly $276 in 2026 to $382 in 2027 – about 38% growth — while tech P/E multiples sit about 19% below their five-year average…
We’ve said for weeks that stocks are on the launchpad, and it looks like they’re starting to launch.
Luke doesn’t expect a smooth ride, given the unresolved conflict with Iran and the midterms. But as he puts it, “The grind higher into the midterms has started.”
So, how will we know if the engine starts to sputter?
First, look to Big Tech itself. When the hyperscalers report in the coming weeks, their spending guidance – how much they plan to pour into chips, data centers and power – tells us whether the money behind AI earnings keeps flowing. Any hint of a slowdown will create fireworks.
So, what’s the portfolio takeaway?
Keep holding your AI stocks – the engine of the economy and the market – but know your specific tripwire. Meanwhile, let forward earnings estimates, not bearish headlines, tell you when to step back.
If you’d like help identifying AI leaders, Louis and Luke are focused on exactly this opportunity.
For the “fundamentally superior” growth stocks Louis expects to benefit from “wave after wave” of positive earnings surprises – including AI, data center, and energy plays, .
And for the AI leaders Luke believes are on the launchpad – the companies with the earnings growth to keep powering this market,
Coming full circle: Last November, our message was “watch earnings.” This year, it’s “watch AI earnings guidance” – the rest is mostly background noise.
Have a good evening,
Jeff Remsburg
(Disclosure: I own GOOGL, AMZN)
