Key points.
- Figures published by American companies show solid profit growth and profitability. However, given the high valuations, investors are becoming more selective about the stocks they reward.
- The performance of the US stock market spans from the technology sector to, among others, industrials, materials, and utilities. Within technology companies, investors are looking for signs of AI monetization.
- In Europe, profit growth is weak, while it exceeds expectations in Japan. Emerging market profits are benefiting from macroeconomic growth drivers, AI, and demand for precious metals.
- We maintain our positive outlook on global equities, preferring emerging markets to developed markets. We favor the utilities, materials, and healthcare sectors.
The earnings season has once again proven remarkable. This fifth consecutive quarter of record double-digit profit growth saw the S&P 500 reach new highs, driven primarily by AI-related capital expenditures, with signs of expansion into the financial and industrial sectors. However, market volatility was also a factor, reflecting the high degree of optimism already priced in. In their earnings analysis, investors are now paying closer attention to companies’ ability to translate spending into revenue.
The fourth-quarter earnings season is pushing profit margins into record territory. Nearly 60% of S&P companies have already reported their figures, showing earnings growth of around 13% year-over-year, almost 8% above consensus estimates (see Chart 1, page 2). Net margins reached 13.2%, their highest level since FactSet began tracking the data in 2009. Twelve-month price-to-earnings ratios are further fueling optimism, having risen above their long-term averages.
However, even though company projections remain generally positive, the risk/return profile has shifted. Market reactions to fourth-quarter results are increasingly nuanced, both between and within sectors. The market is becoming more demanding, rewarding companies that translate their significant capital expenditures into higher margins and revenues, while penalizing those that increase spending without tangible evidence of AI monetization. This change in tone is particularly noticeable among hyperscalers (large-scale data centers), as well as software publishers and data providers. Despite strong results from six of the “Magnificent Seven,” market reactions have been rather negative, with concerns about slowing growth and margin projections for 2026.
The recent correction in the software sector appears to be an overreaction
The recent correction in the software sector appears to be an overreaction. Fears that AI agents will replace traditional software solutions seem exaggerated. While barriers to entry are indeed decreasing, established companies maintain a significant lead in customer data and are already deploying their own agent-based services. We also believe that the computing power required to integrate AI capabilities will fuel sustainable growth across various cloud platforms .
While technology remains the primary driver of earnings growth, stock market performance is now extending to the industrials, materials, and utilities sectors, whose results are benefiting from infrastructure investments, electrification, and the power demands of data centers. More stable macroeconomic conditions and the prospect of further monetary easing in the US are additional tailwinds. We also believe that strong growth in lending and interest income will benefit financial institutions, along with increased activity in capital markets. This underscores that growth is largely, but not exclusively, driven by AI. In a US economy increasingly divided between wealthy consumers and those struggling with modest incomes, consumer discretionary stocks are seeing their earnings falter. In the healthcare sector, growth is stagnating amid increased competition from generic drugs and falling prices. That being said, the product pipeline is abundant and the outlook remains solid.
More moderate European growth, but improving
In Europe, earnings are more mixed. Combining the results of the roughly 25% of companies that have already released their quarterly figures with consensus expectations for the others, earnings growth is close to 5%. Companies are feeling the effects of a strong euro and uneven demand. The financial and industrial sectors remain the main drivers of earnings growth, and their outlook is improving. The utilities sector is benefiting from increased electricity demand and policy support measures. Healthcare and energy earnings have generally moved in line with expectations, and forecasts are generally more favorable. The consumer staples and discretionary sectors remain fragile, with a cautious outlook for the automotive industry, while luxury goods companies are reporting improved conditions in the US and China.
Overall, market reactions have been encouraging, although disappointments are being penalized more heavily than positive surprises are being rewarded. Europe is not benefiting from the AI-driven growth engines in the US, but investors are primarily focused on the cyclical recovery in earnings. We are forecasting a rebound in earnings growth from -3.5% in 2025 to 9% in 2026, a level slightly below the consensus.
Europe is not benefiting from the AI-driven growth engines in the US, but investors are primarily interested in the cyclical recovery of profits.
In Switzerland, the earnings season reflects expectations of improved economic growth, robust performance in the industrial sector (particularly in electrification and automation), resilient financial institutions, and a mixed healthcare sector. With nearly 40% of companies having reported their results, earnings growth combined with remaining expectations stands at 2.5%, below consensus forecasts, primarily due to the strength of the Swiss franc. While solid dividend yields and near-zero interest rates provide support, the upside potential of the Swiss market appears more limited.
Japan surpasses expectations
In Japan, approximately 60% of MSCI index companies have reported earnings, and third-quarter profits, while broadly stable, exceeded expectations thanks to the weak yen, which benefits exporters. The technology (including AI and semiconductor segments), financials, and healthcare sectors also surpassed forecasts, while the consumer sector continues to be hampered by high inflation. Earnings are still being revised upward, reflecting expectations for fiscal stimulus and corporate reform. Following the ruling party’s landslide victory in the February 8 elections, we see further upside potential for Japanese equities. The positive earnings momentum is poised to accelerate again, driven by corporate reforms, fiscal stimulus, and cyclical tailwinds.
Strong earnings in emerging markets
In this context, emerging markets continue to offer a more attractive combination of valuation and earnings momentum than developed markets. The weakening US dollar is a positive factor, but it is primarily the fundamentals that are compelling: emerging markets are posting average earnings growth of around 16% this quarter, exceeding the 8% average of their developed market counterparts. This strength is expected to continue.
Despite significant inflows, international investors remain structurally underweight in emerging markets.
Some emerging markets stand out. In South Korea, the stock market index has seen its earnings expectations rise by about 30% over the past four weeks, driven by demand for memory chips. This trend is unlikely to reverse before 2027. In Taiwan, the logic chip sector is equally robust, supported by long-term supply contracts.
In South Africa, on the other hand, profit growth of over 12% stemmed primarily from demand for precious metals. The Chinese stock market, meanwhile, appears to be stabilizing after two quarters of zero growth, as pressure on margins eases. India faced challenging conditions in the fourth quarter: high tariffs imposed by the United States restricted its companies’ ability to generate growth above 7%. However, the recent reduction in trade barriers will have a positive effect on confidence and should support an acceleration of growth in the coming quarters.
Crucially, despite significant inflows, international investors remain structurally underweight in emerging markets. South Korea and China, with valuations at approximately eight and twelve times earnings respectively, are still attractive compared to those in developed markets. Total return projections remain anchored to earnings growth rather than multiple expansion.
Diversification remains essential
Overall, this favorable macroeconomic backdrop, along with the strength of the fundamentals, justifies our positive view of global equities, despite the recent consolidation stemming from concerns about potential AI disruption and geopolitical risks.
We continue to prefer emerging markets to developed markets.
We continue to favor emerging markets over developed markets. Following excellent performance and given the high valuation levels in the US and the technology sector, diversification remains essential, moving towards regions offering more attractive valuations and improving earnings prospects. We maintain a neutral stance on developed market equities.
From a sector perspective, we maintain our preference for healthcare, materials, and utilities, and continue to avoid consumer staples. Following the recent consolidation, we also see attractive opportunities among quality growth stocks in the technology sector.
Finally, small and medium-sized enterprises (SMEs) continue to hold our interest. A more pronounced cyclical recovery in earnings and easing monetary conditions should allow them to outperform their larger-cap counterparts.
