Equity markets settled back into modest gains in the 3rd quarter after their 2nd quarter Gen AI1 risk-on surge. Rising rates, sovereign debt concerns, and emerging Gen AI skepticism made for a more cautious narrative.
Rising rates are unwelcome news for over-leveraged borrowers, which we are not. Nor do we think rates are high enough systemically to induce a recession just yet. Sovereign debt is a more complicated topic. We will address government finance at some point, but since it does not currently make the Top 5 Worries List for ACR portfolios, we will hold our powder dry for another day. Gen AI skepticism and risks, on the other hand, merit further discussion.
Gen AI may be producing the greatest technology hype cycle ever. The storyline is irresistible. Humankind has finally cracked the code on super-intelligence (defined here as a single source more intelligent than the smartest expert in every field). You can see it with your own two eyes. Punch a query into your favorite Gen AI chat – and voila! – an intelligent response from a subject matter expert appears. Or better yet, type in a few commands and become your own personal software company! And it will only get better. More “compute” guarantees greater intelligence. The hype masters are the most compelling aspect of the story. None other than the greatest engineering genius of our age is all-in to the tune of a multi-trillion-dollar valuation, along with a coterie of the richest, most successful technologists in the world. How dare little ‘ole you deign to be skeptical!
For scathing skepticism, you can explore two erudite, well-supported papers on AI by our own James Montier in Curmudgeon’s Corner, with his third and final coming out any day now. The ACR investment team is roundly suspicious of super-intelligence claims, hyper growth forecasts, and fears of mass unemployment. But the story is not black and white. We believe Gen AI is a disruptive technology that will be built into enterprise workflows and consumer products for many years to come. Our hope is for a tailwind to productivity, though it is too soon to say how measurable the gains will be. As revolutionary as the Internet was, pinpointing the timing and level of its productivity gains is still difficult. In addition to cybersecurity risk, the economic risks of the Gen AI buildout are our greatest concern. They include over-building, a recessionary bust, and disappointing return on investment. James addresses these risks in his essays, and we will elaborate on them in our year-end commentary.
In this quarter’s commentary, we highlight how the historic Gen AI buildout is creating a one-time distortion in corporate profits. Our 2nd quarter commentary traced the yawning gap between earnings and free cash flow driven by the Gen AI capital expenditure spending boom. The charts on the following page provide additional context for this unprecedented conversion of costs into earnings.
The top chart shows the relationship between AI capital expenditures and AI supply chain net income. The bottom chart shows the estimated contribution to earnings this and next year. It is an accounting fact that these capital expenditures will become future depreciation charges which will lower reported hyperscaler earnings. Should the capital expenditures boom slow, a future index earnings double whammy would be in store as Gen AI supply chain profits recede. We will explore the consequences of over-building and potential asset write-downs in our year-end commentary.
The table highlights both the Gen AI Supply Chain estimated contribution to earnings and the even more stunning contribution to earnings growth. Included in 2026 As Reported Earnings are an additional $200 billion of estimated paper profits of firms like Google who have written up their Anthropic investment. If corporate earnings are forecasted to grow without AI, why worry about temporary excess profit growth? There are two reasons. The first is to be mindful of the reversal of these trends and the dynamics this could entail. The second is to understand that even though reported P/E ratios are historically high, they are even higher than shown due to the current temporary distortion in earnings.
This leads us to what we think is the greatest risk for investors – high equity prices relative to sustainable underlying profits. Value investors like us have been crying wolf on valuations for years and have been wrong as cyclically adjusted P/E ratios continue to rise rather than fall. Yet our intent is not to call tops or bottoms. It is to contain a risk while still generating a respectable return. The bad news is the more “wrong” we are in the shorter term, the more painfully right we are likely to be in the longer term. Our goal is to protect ACR clients from such an outcome by maintaining portfolios with vastly different valuation characteristics from the market. The Gen AI boom may extend the secular bull market longer and further than we think, but whether we are in the 5th or 9th inning of this great hype cycle, we will continue managing risk for a day of reckoning while seeking a satisfactory return.
Nick Tompras
October 2026
End Note
1. For clarity, we use “Gen AI” to distinguish the form of artificial intelligence that entered widespread public use with ChatGPT’s release in November 2022. Gen AI models encode patterns learned from training data in statistical parameters and use those patterns to synthesize text, images, or code, rather than simply retrieving stored records or applying explicit rules. Their outputs are newly composed and typically probabilistic, so responses to the same request can vary. Earlier AI and machine learning generally focused on classification, prediction, or optimization, although they also employed statistical methods. We believe many applications require combining Gen AI with verified records and other computational methods to improve reliability which limits Gen AI as a general intelligence tool.
IMPORTANT DISCLOSURES
ACR Alpine Capital Research LLC is an SEC-registered investment adviser. For more information, please refer to Form ADV on file with the SEC at www.adviserinfo.sec.gov. Registration with the SEC does not imply any particular level of skill or training.
Unless otherwise noted, all statistics highlighted in this research note are sourced from ACR’s analysis.
It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the examples discussed. You should consider any strategy’s investment objectives, risks, charges, and expenses carefully before you invest.
This information should not be used as a general guide to investing or as a source of any specific investment recommendations and makes no implied or expressed recommendations concerning the manner in which an account should or would be handled, as appropriate investment strategies depend upon specific investment guidelines and objectives. This is not an offer to sell or a solicitation to invest.
This information is intended solely to report on investment strategies implemented by Alpine Capital Research (“ACR”). Opinions and estimates offered constitute our judgment as of the date set forth above and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. There are risks associated with purchasing and selling securities and options thereon, including the risk that you could lose money. All material presented is compiled from sources believed to be reliable, but no guarantee is given as to its accuracy.
The investment outlook represents ACR’s views on the economic factors that may affect the global capital markets. There can be no guarantee that these factors will necessarily occur as ACR anticipates, nor that if they do, they will lead to positive performance returns. There can be no assurance that any objective will be achieved.The Equity Quality Return (EQR) Total Accounts Composite consists of equity portfolios managed for non-wrap fee and wrap fee clients according to the Firm’s published investment policy. The composite investment policy includes the objective of providing satisfactory absolute and relative results in the long run and preserving capital from permanent loss during periods of economic decline. EQR invests only in publicly traded marketable common stocks. Total Return performance includes unrealized gains, realized gains, dividends, interest, and the re-investment of all income. Pure Gross returns are gross of all fees and do not reflect the deduction of transaction costs in wrap portfolios. Pure Gross returns are supplemental information. Net of ACR Fee returns are Pure Gross returns reduced by 1.0% per annum, which is the standard management fee for the Equity Quality Return strategy. Please refer to our full composite performance presentation with disclosures published under the Strategies section of our website at https://acr-invest.com/strategies/eqr-equity-quality-return-performance/
The S&P 500 TR Index is a broad-based stock index that includes dividend reinvestment and has been presented as an indication of domestic stock market performance. It is unmanaged and cannot be purchased by investors.
The AI Earnings Lump
3Q 2026
Equity markets settled back into modest gains in the 3rd quarter after their 2nd quarter Gen AI1 risk-on surge. Rising rates, sovereign debt concerns, and emerging Gen AI skepticism made for a more cautious narrative.
Rising rates are unwelcome news for over-leveraged borrowers, which we are not. Nor do we think rates are high enough systemically to induce a recession just yet. Sovereign debt is a more complicated topic. We will address government finance at some point, but since it does not currently make the Top 5 Worries List for ACR portfolios, we will hold our powder dry for another day. Gen AI skepticism and risks, on the other hand, merit further discussion.
Gen AI may be producing the greatest technology hype cycle ever. The storyline is irresistible. Humankind has finally cracked the code on super-intelligence (defined here as a single source more intelligent than the smartest expert in every field). You can see it with your own two eyes. Punch a query into your favorite Gen AI chat – and voila! – an intelligent response from a subject matter expert appears. Or better yet, type in a few commands and become your own personal software company! And it will only get better. More “compute” guarantees greater intelligence. The hype masters are the most compelling aspect of the story. None other than the greatest engineering genius of our age is all-in to the tune of a multi-trillion-dollar valuation, along with a coterie of the richest, most successful technologists in the world. How dare little ‘ole you deign to be skeptical!
For scathing skepticism, you can explore two erudite, well-supported papers on AI by our own James Montier in Curmudgeon’s Corner, with his third and final coming out any day now. The ACR investment team is roundly suspicious of super-intelligence claims, hyper growth forecasts, and fears of mass unemployment. But the story is not black and white. We believe Gen AI is a disruptive technology that will be built into enterprise workflows and consumer products for many years to come. Our hope is for a tailwind to productivity, though it is too soon to say how measurable the gains will be. As revolutionary as the Internet was, pinpointing the timing and level of its productivity gains is still difficult. In addition to cybersecurity risk, the economic risks of the Gen AI buildout are our greatest concern. They include over-building, a recessionary bust, and disappointing return on investment. James addresses these risks in his essays, and we will elaborate on them in our year-end commentary.
In this quarter’s commentary, we highlight how the historic Gen AI buildout is creating a one-time distortion in corporate profits. Our 2nd quarter commentary traced the yawning gap between earnings and free cash flow driven by the Gen AI capital expenditure spending boom. The charts on the following page provide additional context for this unprecedented conversion of costs into earnings.
The top chart shows the relationship between AI capital expenditures and AI supply chain net income. The bottom chart shows the estimated contribution to earnings this and next year. It is an accounting fact that these capital expenditures will become future depreciation charges which will lower reported hyperscaler earnings. Should the capital expenditures boom slow, a future index earnings double whammy would be in store as Gen AI supply chain profits recede. We will explore the consequences of over-building and potential asset write-downs in our year-end commentary.
The table highlights both the Gen AI Supply Chain estimated contribution to earnings and the even more stunning contribution to earnings growth. Included in 2026 As Reported Earnings are an additional $200 billion of estimated paper profits of firms like Google who have written up their Anthropic investment. If corporate earnings are forecasted to grow without AI, why worry about temporary excess profit growth? There are two reasons. The first is to be mindful of the reversal of these trends and the dynamics this could entail. The second is to understand that even though reported P/E ratios are historically high, they are even higher than shown due to the current temporary distortion in earnings.
This leads us to what we think is the greatest risk for investors – high equity prices relative to sustainable underlying profits. Value investors like us have been crying wolf on valuations for years and have been wrong as cyclically adjusted P/E ratios continue to rise rather than fall. Yet our intent is not to call tops or bottoms. It is to contain a risk while still generating a respectable return. The bad news is the more “wrong” we are in the shorter term, the more painfully right we are likely to be in the longer term. Our goal is to protect ACR clients from such an outcome by maintaining portfolios with vastly different valuation characteristics from the market. The Gen AI boom may extend the secular bull market longer and further than we think, but whether we are in the 5th or 9th inning of this great hype cycle, we will continue managing risk for a day of reckoning while seeking a satisfactory return.
Nick Tompras
October 2026
End Note
1. For clarity, we use “Gen AI” to distinguish the form of artificial intelligence that entered widespread public use with ChatGPT’s release in November 2022. Gen AI models encode patterns learned from training data in statistical parameters and use those patterns to synthesize text, images, or code, rather than simply retrieving stored records or applying explicit rules. Their outputs are newly composed and typically probabilistic, so responses to the same request can vary. Earlier AI and machine learning generally focused on classification, prediction, or optimization, although they also employed statistical methods. We believe many applications require combining Gen AI with verified records and other computational methods to improve reliability which limits Gen AI as a general intelligence tool.
IMPORTANT DISCLOSURES
ACR Alpine Capital Research LLC is an SEC-registered investment adviser. For more information, please refer to Form ADV on file with the SEC at www.adviserinfo.sec.gov. Registration with the SEC does not imply any particular level of skill or training.
Unless otherwise noted, all statistics highlighted in this research note are sourced from ACR’s analysis.
It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the examples discussed. You should consider any strategy’s investment objectives, risks, charges, and expenses carefully before you invest.
This information should not be used as a general guide to investing or as a source of any specific investment recommendations and makes no implied or expressed recommendations concerning the manner in which an account should or would be handled, as appropriate investment strategies depend upon specific investment guidelines and objectives. This is not an offer to sell or a solicitation to invest.
This information is intended solely to report on investment strategies implemented by Alpine Capital Research (“ACR”). Opinions and estimates offered constitute our judgment as of the date set forth above and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. There are risks associated with purchasing and selling securities and options thereon, including the risk that you could lose money. All material presented is compiled from sources believed to be reliable, but no guarantee is given as to its accuracy.
The investment outlook represents ACR’s views on the economic factors that may affect the global capital markets. There can be no guarantee that these factors will necessarily occur as ACR anticipates, nor that if they do, they will lead to positive performance returns. There can be no assurance that any objective will be achieved.The Equity Quality Return (EQR) Total Accounts Composite consists of equity portfolios managed for non-wrap fee and wrap fee clients according to the Firm’s published investment policy. The composite investment policy includes the objective of providing satisfactory absolute and relative results in the long run and preserving capital from permanent loss during periods of economic decline. EQR invests only in publicly traded marketable common stocks. Total Return performance includes unrealized gains, realized gains, dividends, interest, and the re-investment of all income. Pure Gross returns are gross of all fees and do not reflect the deduction of transaction costs in wrap portfolios. Pure Gross returns are supplemental information. Net of ACR Fee returns are Pure Gross returns reduced by 1.0% per annum, which is the standard management fee for the Equity Quality Return strategy. Please refer to our full composite performance presentation with disclosures published under the Strategies section of our website at https://acr-invest.com/strategies/eqr-equity-quality-return-performance/
The S&P 500 TR Index is a broad-based stock index that includes dividend reinvestment and has been presented as an indication of domestic stock market performance. It is unmanaged and cannot be purchased by investors.
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