Must Read Research
Also featuring commentary from our economists
October 5, 2025
Candace Browning, Head of BofA Global Research
This season, market leaders are changing with the leaves. We explore how profit growth is turning up for small caps, address concerns about how long AI capex can stay in the green, look into the stiff winds facing low-end hotels and discuss whether bullish sentiment suggests the emerging market (EM) rally is headed for a fall.
Earnings growth is broadening beyond mega caps and is now extending into small caps.
The Russell 2000’s 3% gain last month was driven entirely by EPS (earnings per share) revisions, not multiple expansion – its forward P/E stayed flat at 16.2x while implied earnings saw their strongest change since mid-2022. EPS and sales revisions are at multi-year highs, and consensus expects small cap profits to outpace large caps in 4Q and through 2026. This improved growth comes with attractive valuations: small caps trade ~30% below large caps (0.72x P/E vs. 0.99x historical avg.) and imply ~8% annualized returns over the next decade versus <1% for the Russell 1000. Mid caps are also historically cheap relative to mega caps, a setup Head of U.S. Small and Mid Cap Strategy Jill Hall favors. Within small caps, Value looks especially well-positioned as Fed cuts rates, signal a shift into “Recovery” in the U.S. Regime Indicator, and rising breadth all reinforce the case for rotation. Growth, meanwhile, remains expensive and more exposed in case of higher yields.
Senior U.S. Semiconductors and Semiconductor Capital Equipment Analyst Vivek Arya examines investor concerns around the durability of AI capex and remains very bullish.
He predicts AI investments to nearly triple between 2025 and 2030, constrained only by the capacity to scale buildings and power. While prior cycles may have been funded by debt, this cycle is supported by strong hyperscaler cash flows and government buyers. Consumer adoption is relatively assured since there’s no need to upgrade devices, unlike past cycles such as 4G wireless. We raise our calendar year 25 cloud capex estimate to 58% growth and see a path to $1.2 trillion by 2030E.
Formerly a group that was resilient across cycles, lower-end hotels are now underperforming, with the RevPAR (Revenue Per Available Room) gap versus higher end chains widening well beyond its historical 0.2% average.
Traditional demand drivers — GDP (gross domestic product), corporate profits, and lodging activity — have decoupled. Since 2023, corporate profits have risen to 5.8% annually while lodging revenue has grown only 2%. A “K-shaped” consumer recovery is exacerbating the problem, with lower-income cohorts cutting travel spend and showing the weakest future intentions. Travel’s high cost and advance planning nature make it especially vulnerable to pullbacks. Structurally, vehicle miles driven have plateaued, erasing a key tailwind for roadside hotels and motels. Low-end chains’ heavy exposure to underperforming Sunbelt markets and limited presence in stronger urban centers further weighs on results.
The rally in Emerging Markets, fueled by AI and loose global liquidity faces overbought sentiment indicators and we’ve become tactically more cautious.
Our EMFX carry sentiment indicator, Chief Investment Strategist Michael Hartnett’s cash rule and the Asia equity team’s Risk-Love Sentiment indicator suggest a pullback is likely. Head of Global Emerging Markets Fixed Income Strategy David Hauner observes that markets appear increasingly reliant on “this time is different’ narratives tied to AI and crypto. While AI-driven global growth could justify tighter EM spreads and support currencies like CNY, KRW, SGD and TWD, David believes the impact ultimately hinges on the USD. AI-led productivity would be bullish for EM as long as it’s accompanied by a weaker dollar. If AI leads to bigger U.S. productivity gains and a stronger dollar, that’s a risk. Crypto has boosted liquidity but poses long-term risks by competing with weak fiat currencies and accelerating dollarization. Crypto supply already exceeds by 3x the USD in circulation abroad, and stablecoins now rival AUM (assets under management) tracking the largest EM local debt index.
Claudio Irigoyen, Head of Global Economics, BofA Global Research
United States: A deepening conundrum
Our U.S. Economics team have upgraded their 3Q growth forecast from 1.5% to 2.7% due to robust consumer spending. They also have pulled forward their next Fed cut view from December to October as labor data remains soft. The best explanation for the consumer-labor conundrum is: i) the labor slowdown is largely due to supply, and ii) higher-income spending has been buoyed by equity wealth effects. The team still expects only another 25bp (basis points) of cuts under Powell. But the risk is that the Fed will over-ease because it is slow to accept the labor supply story.
Euro area: So far, not so good
We continue to find reasons why the Euro area economy is not in a good place. Activity is weak, soft data moving sideways and the payback from 1H25 frontloading is still awaited. Inflation strength in Sept is likely to unwind, too. The moves in FX and real rates led to a tightening equivalent to 1 or 2 policy rate hikes since the June meeting.
