Taking stock of Q2 earnings and equity market strength

We assess a solid earnings season led predominantly by AI beneficiaries and the growing risks facing equity markets. These include the impact of tariffs and slowing growth on extended investor positioning and strong market gains year-to-date. However, we still expect robust earnings growth to support equities; we favour communication services within sectors, and emerging markets among regions.

The second quarter US earnings season, now entering its final stages, looks solid at an aggregate level, with S&P 500 companies growing earnings by around 9%, just above the 10-year average, and 80% beating earnings estimates. Margins are expanding, and companies are managing tariff risk to date through supply chain adjustments, price increases and robust cost discipline. While we expect a material slowing of the US economy in the second half, we see recession risks as contained, which should allow corporate earnings to keep growing. Indeed, since the start of the reporting season, full year 2025 and 2026 consensus earnings estimates for global equities have ticked up.

We see recession risks as contained, which should allow corporate earnings to keep growing

Tech and financials do the heavy lifting

Yet a closer look at US earnings reveals a more mixed picture across sectors. The performance of tech and communication services carried the index, and is driving earnings upgrades globally. There was some evidence in Q2 that vast AI capital expenditure is starting to pay off, through rising cloud computing and digital advertising revenues. A weaker dollar helped tech giants with large international sales. The AI tailwind also lifted selected industrials and utilities, amid renewed growth in power demand from data centres and electrification, while solid capital market activity saw financials perform better than expected. Yet a number of more traditional cyclical and defensive sectors, including materials, industrials, healthcare, and consumer staples, did less well.

In Europe, Q2 earnings growth was better than anticipated, but against very low expectations. Financials made a big positive contribution, and the US-EU trade deal lifted some uncertainties. But the stronger euro saw revenues fall at the MSCI EMU index level, and the autos sector in particular suffered. A spate of profit warnings highlighted the uncertain policy regime in which companies are operating. Earnings estimates for European firms in 2025 and 2026 have been drifting downwards, across all sectors except financials, in the past month.

There was some evidence in Q2 that vast AI capital expenditure is starting to pay off

Emerging markets benefit from long-term growth drivers

For emerging markets, the Q2 earnings season is still in its early stages, but a slowdown is expected, with ‘blended’ earnings growth (that of companies having reported, plus consensus expectations for those that have not) of around 2%. Companies in South East Asia face headwinds from global trade uncertainties, Chinese ecommerce firms are suffering from intense competition and Saudi Arabia’s contribution will be negative due to low oil prices. However, consensus estimates see an earnings recovery in the latter part of the year, and a decent outlook for 2026.

Emerging market valuations are also lower than those in other regions, and positive long-term earnings drivers remain in place. These include rising semiconductor chip demand for Korea and Taiwan, rising domestic demand for India and China – which is also seeing a drive to remove unproductive capacity in the economy – and corporate governance reforms in Korea. Emerging market stocks are still ‘under-owned’ by foreign investors, who are increasingly looking to diversify their portfolios from US assets. A weaker dollar should also help profits in US dollar terms.

Emerging market valuations are lower than those in other regions, and positive long-term earnings drivers remain in place

Should we still expect fresh highs?

Concerns about tariffs and a US labour market and services slowdown have not stopped many equity indices from reaching new highs in recent months. As a result, investors have grown nervous, in light of continued uncertainties. For example, the impact of tariffs will be felt more fully from Q3 onwards. Investor positioning in equities has risen, especially among retail investors. Market gains this year have been far and fast, and led by a narrow group of stocks. US valuations in particular remain fairly full.

our expertise.

rethink investments.

learn more

private banking.

learn more

However, we also see the following counterarguments. While overall investor positioning is a growing risk, we see few signs of speculative excesses to date. In the US, the equity market is no longer an effective proxy for the real economy, with AI beneficiaries somewhat disconnected from the short-term macro picture. A period of slower earnings growth has already been priced into Q3 estimates, as companies adjust to the impact of higher tariffs. Meanwhile, interest rate cuts from the Federal Reserve – we forecast three ahead this year – should help support elevated valuations. 

In the US, the equity market is no longer an effective proxy for the real economy

Of course, we are monitoring all the risk factors for equity markets very closely. In early July we took some profits on developed market equities in the wake of an unusually swift rally since April’s sell-off and expectations of slower economic growth and higher market volatility ahead. Our preferred region remains emerging markets, and our preferred sector remains communication services – which benefits from many of the positive elements driving tech stocks, but trades at a more reasonable price.

In summary, earnings and technical market dynamics remain clear tailwinds for equities, while a deteriorating macro outlook and growing valuation headwind are not yet sufficient enough for us to turn cautious on the asset class, reinforcing the argument to stay invested.