Dear readers,
On Saturday we wrote that the market wanted software margins to justify the hardware bill. On Wednesday, it gets its answer — and the stakes could hardly be higher.
The S&P 500 and Nasdaq closed Monday at fresh record highs of 7,173.93 and 24,887.10, respectively. But the rally now faces a gauntlet of earnings reports that will determine whether the largest capital expenditure cycle in corporate history is producing returns or just burning cash. Microsoft, Meta, Alphabet, and Amazon collectively plan to spend an estimated $600 to $650 billion on AI infrastructure in fiscal 2026. Starting Wednesday, each of them has to explain what shareholders are getting for the money.
Microsoft: The Margin Question No One Can Dodge
Microsoft sits at the center of the reckoning. The stock has shed roughly 12% year-to-date and trades nearly 24% below its 52-week high — a discount that tells you the market has already begun discounting the possibility that AI spending overwhelms near-term profitability.
For the fiscal third quarter due Wednesday, analysts expect earnings per share of $4.06 on revenue of $81.3 billion, a 16.3% year-over-year increase. Solid growth by any normal standard. But the real scrutiny falls on margins. With approximately $80 billion in planned capital expenditures for fiscal 2026, Microsoft’s cloud gross margin is projected to compress to 65% in Q3. Free cash flow came in at $5.9 billion last quarter — positive, but declining sequentially. The ServiceNow margin scare we flagged Saturday, when a 2026 gross margin forecast of 81.5% rattled the entire software sector, has primed investors to punish any hint of similar compression.
Copilot’s Adoption Problem — and the OpenAI Complication
The critical question is monetization velocity, and the early data is sobering. Of Microsoft’s roughly 450 million enterprise customers, just 3.3% currently pay for the $30-per-month Copilot service. Reports from the enterprise channel suggest willingness to pay remains thin. Microsoft is pushing harder on the developer side: GitHub Copilot goes paid on June 1, with tiers at $10, $19, and $39 per month. Whether that moves the needle remains an open question.
Then there is the revised OpenAI partnership. The exclusivity arrangement is gone. OpenAI can now serve customers through competing cloud platforms, including Amazon’s AWS. Microsoft retains a 20% revenue share on OpenAI sales through 2030, but the AI company has reportedly missed its own internal revenue and user targets. That weakness hit OpenAI partners on Tuesday: Oracle shares dropped 6.5% in premarket trading. Still, not everyone is running for the exits. Michael Burry, among other prominent investors, has recently built long positions in Microsoft, drawn by the durability of Azure and Office 365 — businesses that generate enormous margins regardless of how the AI bet plays out.
The Magnificent Seven Minus Nvidia: A Telling Decomposition
Here is a number that deserves more attention than it has received. Strip Nvidia out of the Magnificent Seven, and the remaining six companies are growing first-quarter earnings at an estimated 6.4% — their weakest pace in two years. That figure falls below the 10.1% earnings growth rate FactSet projects for the other 493 companies in the S&P 500. For the first time since the AI trade ignited, the mega-caps excluding their chip supplier are being outgrown by the rest of the index. The broader earnings season, meanwhile, has been strong: 81% of S&P 500 companies have beaten estimates so far.
European Dispatches: Volkswagen’s Confession, Spotify’s Proof
Volkswagen delivered a blunt internal assessment this week. CFO Arno Antlitz told executives that existing efficiency programs are insufficient, and that the company is not making enough money on its vehicles despite billions in cost cuts already executed. Antlitz called for a fundamental overhaul of the business model under the “Strategy 2030” framework. The language was unusually stark for a company that has spent years promising incremental improvement.
Spotify, by contrast, offered a masterclass in margin expansion. The streaming company posted Q1 revenue of €4.53 billion, up 8%, with a record gross margin of 33.0%. Free cash flow reached €824 million, powered by 293 million premium subscribers. If Microsoft is the test case for whether AI spending destroys margins, Spotify is the counterexample — a tech company proving that disciplined cost management can coexist with growth.
The Fed, Oil, and the Week’s Other Variables
The Federal Reserve announces its rate decision Wednesday. Markets are pricing a 100% probability that the fed funds rate holds at 3.50–3.75%. It will also be Jerome Powell’s final press conference before stepping down on May 15. Brent crude remains elevated near $109 per barrel amid the ongoing Strait of Hormuz blockade, and the UAE’s surprise announcement that it will exit OPEC effective May 1 adds a new variable to the supply picture. Bitcoin, meanwhile, has failed repeatedly to clear $80,000 and slipped to approximately $76,800 following $263 million in spot ETF outflows on Monday.
The Takeaway
The next 48 hours will answer the question this market has been deferring for months. The hardware buildout is funded. The capex checks are written. What Wednesday’s earnings need to demonstrate is that the software and services layer — Copilot adoption, Azure AI workloads, enterprise agent deployments — is converting those billions into durable, recurring revenue. If Microsoft can show margin stabilization alongside accelerating AI monetization, the record highs hold. If the numbers reveal that spending is running well ahead of demand, the compression trade that started with ServiceNow spreads to the largest companies on earth. The market has been remarkably patient with the AI investment thesis. Patience, as a rule, does not survive earnings season.
Best regards,
The StocksToday.com Editorial
