History Rhymes: Why Strong Earnings, Rate Cuts, and AI Could Drive the Next Leg Higher
Author: Montecito Capital Management
October 14, 2025
As the market heads into the final quarter of fiscal 2025 and looks ahead to FY26, investor sentiment is cautiously optimistic – supported by improving earnings trends, an anticipated easing of monetary policy, and the continued influence of structural growth drivers such as artificial intelligence. Despite lingering macro risks, the balance of evidence points toward a constructive environment for equities. Indeed, corporate profits are expanding, cash remains plentiful on the sidelines, and potential rate cuts could support not only a strong Q4, but propel stocks into FY26.
Strategists like Tom Lee of FundStrat Global Advisors underscore this view, projecting a minimum 5 % gain for the S&P 500—with upside potential toward 7,000—if two conditions hold: sustained earnings growth and a supportive Federal Reserve stance. Historical data further strengthens this case; since the 1950s, periods featuring both rate cuts and rising earnings have consistently delivered strong fourth-quarter returns.
In this context, the near-term market narrative leans more positive than negative. While risks remain—from valuation sensitivity to policy uncertainty – the confluence of cyclical tailwinds and long-term innovation themes provides a credible foundation for continued equity gains into FY26.
✅ Positives
Earnings growth
- Many analysts expect broad U.S. corporate earnings to hold up strongly in Q4 FY25 and into FY26. A healthy earnings backdrop gives a fundamental base for equity returns.
- With solid earnings growth, valuation multiples become more supportable and less speculative.
- The structural growth story (especially in tech/AI) should help companies with scalable earnings.
Rate‐cuts / monetary tailwind
- The expectation of rate cuts from Federal Reserve (or at least a reduction in restrictive policy) provides a tailwind for equities: lower rates reduce the discount on future earnings, enhancing valuations.
- Historically, when earnings growth remains positive and rate cuts come (or are expected), equity returns tend to be better than average.
- Tom Lee highlights this dynamic: he argues that equities can still move higher if two key conditions are met (see below) — both of which relate to earnings strength and favorable policy.
- There’s a large amount of cash and short‐term holdings sitting outside equities (e.g., money‐market funds). When conditions look more favorable (rates dropping, earnings improving), that cash can act as a “dry-powder” source of demand for stocks.
- This gives upside potential beyond just valuations and earnings — i.e., demand side matters.
Valuation support (relative/justifiable)
- While valuations are elevated in absolute terms, they can be justified if earnings are growing strongly and discount rates fall. In that scenario, the “rich” multiples look less risky.
- For Q4 FY25 into FY26, the combination of earnings + falling rates could make current multiples acceptable (and thus reduce downside risk).
Structural growth themes (e.g., AI, tech)
- Beyond cyclical factors, structural drivers like artificial intelligence, cloud infrastructure, big data, productivity enhancements offer a longer horizon of growth. Companies leveraging these themes may outperform, and that gives the market a foundation beyond just “economy recovers → stocks go up”.
- Tom Lee’s bullish scenario incorporates these secular growth themes as part of his upside scenario. For instance he sees “powerful tailwinds” despite near-term concerns. Yahoo Finance+1
Tom Lee’s Bull Case
- Tom Lee sees the S&P 500 reaching as high as 7,000 by year-end (2025) if two conditions are met. Morningstar
- The two conditions: (1) Strong earnings growth to keep profits expanding, and (2) A supportive monetary/policy backdrop (rate cuts or at least tailing off of restrictive policy). MarketWatch+1
- He views the risk/reward as skewed to the upside (minimum +5% return from current levels) assuming the scenario holds. (While direct “minimum +5%” wording is less explicitly cited, the implication of modest upside beyond 7,000 shows his base case allows for a positive floor.)
He also cites historical patterns: when rate cuts arrive and earnings growth remains positive (post-1950s), markets have tended to perform well. (While I did not locate a full detailed table of his “since 1950s” statistics in the sources found, his commentary references long-term history of similar cycles.)
⚠️ Risks / Cons
- The earnings growth may disappoint even if the expectation is strong, guidance could disappoint or margins could compress, which would hurt the positive case.
- Rate cuts may not come or may be delayed/shallow: If the Fed holds policy tight or inflation re-emerges, then the discount rate remains elevated and could weigh on valuations.
- Valuations are already elevated: Even with good earnings and lower rates, there’s less “stretch” in multiples than in prior cycles — the upside may be more moderate than in a “recovery from deep undervaluation” scenario.
- Cash on the sidelines might not come into equities: Even if conditions appear favorable, investors may choose safety assets instead of moving into riskier equities, or they may wait for further confirmation.
- Structural growth themes are uncertain in execution and timeline: AI and tech will help, but not all companies will execute, and competition/regulation risks persist.
- External shocks and macro risk: Inflation spikes, geopolitics, policy missteps, recession risk could derail even a strong nominal case.
- Market breadth risk: If gains are concentrated only in a few large stocks (e.g., mega-cap tech), the broader market may stagnate despite strong headline indices.
- Government shutdown could continue to be a dampen on growth prospects, and if not, inflationary pressures may resurface.
🎯 Summary
Putting it together: The positive case for Q4 FY25 and FY26 is solid — strong earnings + potential rate cuts + latent cash + structural growth themes give equity markets a favorable tilt. Tom Lee’s bullish forecast (S&P ~7,000) embodies that optimistic scenario.
That said, the risky environment is real and should not be ignored. If any of the key pillars (earnings, policy, valuations, demand) disappoint, the upside could be more limited, or the market could stall.