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Strong earnings reflect AI support – and valuation concerns
Dr. Luca Bindelli
Head of Investment Strategy
Patrick Kellenberger
Emerging Market Equities Strategist
key takeaways.
Third-quarter corporate earnings are proving broadly positive, with developed markets surpassing expectations and emerging markets showing potential for earnings acceleration
AI capital expenditure and higher margins are driving stock performance, especially in the US and South Korea
Investors are becoming more discerning. Despite earnings beats, share price reactions in the US have been muted, reflecting high expectations and closer investor scrutiny
We maintain our moderately pro-risk portfolio positioning. While valuations in developed markets – especially the US – look elevated, fundamentals are still supportive. We favour emerging markets’ attractive earnings growth at lower valuations, plus Swiss and Japanese equities’ rebound potential and earnings momentum.
At the halfway point of the third-quarter reporting season, corporate earnings are broadly positive, with some variation across regions and sectors. Developed markets are outperforming undemanding expectations, while emerging markets show solid growth and may accelerate in the fourth quarter. Three key themes stand out: still-rising AI-related capital expenditure, margin expansion, and more cautious investor reactions to earnings beats.
In the US, the earnings season has been particularly strong. With three-quarters of the MSCI USA index’s firms having reported, 81% have beaten earnings-per-share (EPS) estimates. On average, companies have increased EPS by 13% compared to the same period last year and earnings have been 8% stronger than forecast. Robust demand and margin expansion have underpinned performance to date, especially in tech and sectors tied to the building of AI infrastructure.
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The frequency of sizeable earnings beats – more than one standard deviation above the historical norm – is unprecedented outside the Covid pandemic recovery. This highlights both the resilience of corporate profitability and the impact of structural growth drivers like AI.
The frequency of sizeable earnings beats is unprecedented outside the Covid pandemic recovery
While analyst expectations were modest heading into this reporting season – partly due to uncertainties over the impact of US import tariffs – market expectations were higher. As a result, companies beating estimates have recorded lower-than-typical share price gains, suggesting investors had already priced-in strong performance. The US’s import tariffs are not yet impacting results meaningfully, and are shared between US businesses, especially smaller firms, US consumers and foreign exporters, but may yet become more visible in the earnings of listed companies. The fact that earnings beats are being less rewarded than historically also suggests a healthy level of investor scepticism.
The industrial, utilities and materials sectors have all posted solid results in the US, and financials have been buoyed by capital market activity – although market reactions to bank earnings were more muted since some concerns over credit exposures linger. In contrast, defensive stocks excluding utilities, consumer discretionary in autos or housing, as well as energy, are all lagging in terms of earnings growth. Healthcare providers remain under pressure from the US government’s cost-saving efforts, though results have been better than feared. Company guidance and analyst revisions remain optimistic, and a growing focus on labour efficiency, alongside rising layoffs, suggests corporates are preparing for productivity improvements that are not yet directly linked to AI.
The fact that earnings beats are being less rewarded than historically also suggests a healthy level of investor scepticism
Strength in Japan, Switzerland, emerging markets
Beyond the US, the picture is more nuanced but still constructive. While earnings growth is significantly weaker, strong beats suggest few tariff headwinds for now. Japan’s corporate sector is on track for 5% earnings growth driven by overseas demand, particularly in electronics and precision manufacturing. Switzerland’s strength, meanwhile, is largely financials-driven, while the euro area shows resilience in financials, industrials – including defence – and real estate, while the automotive and utilities sectors are a drag on the market.
In emerging markets, half of the MSCI EM index constituents have reported, with 5% EPS growth slightly ahead of expectations. South Korea leads with 34% EPS growth, driven by information technology and industrials, while Taiwan and India also posted solid results. China remains weak, with -1% EPS growth and ongoing margin pressure, though AI-related sectors offer some bright spots. Brazil, despite economic headwinds and lower commodity prices, performed better than feared.
Looking further ahead, emerging markets are expected to see their EPS growth accelerate between the third and fourth quarters of 2025, while developed markets may experience a slowdown. Earnings revisions over the past two months have been broadly positive, especially in the UK, Japan, and the US, with emerging market revisions even stronger – led by South Korea, Taiwan, and Brazil.
Emerging markets are expected to see their earnings growth accelerate between the third and fourth quarters, while developed markets may experience a slowdown
Bubble trouble?
AI remains a key driver for equities, and infrastructure investments continue to surprise markets with their acceleration. Concerns around AI lie in the sector’s high valuations, that for some key players – partly private – are based on future revenues rather than profitability at this stage.
Yet capital expenditure by the hyperscalers – those tech businesses dominating the cloud computing market with massive set-ups and scalability – is expected to rise by 32% in 2026, compared with a 20% rise forecast just a few weeks ago at the start of the earnings season. This supports expectations of a longer lasting investment cycle that should support the ‘pick and shovel’ names in the tech industry, and sectors related to the infrastructure buildout such as industrials, utilities and materials. In contrast with the dot-com bubble of a quarter of a century ago, prices have remained fundamentally connected to firms’ abilities to generate profits.
In addition, most of the hyperscalers have been capable of covering their investments from the proceeds of their operating activities, which continue to grow at a solid pace, only starting to use debt against very strong balance sheets. However, this earnings season has shown that the market is beginning to scrutinise the potential for these businesses to generate returns from their customer base more carefully. Last week saw two of these businesses raise a total of USD 55 billion in debt to fund data centre and cloud infrastructure. Both attracted high investor demand, suggesting confidence in big tech’s balance sheet and strategy, despite some caution over whether some of this represents overspending.
Hyperwinners?
With AI technology evolving quickly, more powerful semiconductors are in the pipeline and no-one knows the eventual impact of AI, or who the winners will be. This said, companies enabling the buildout should continue to benefit from rising investments while the existing US hyperscalers have a sizeable advantage; no other companies have comparable resources, and the buildout they are engaged in is expensive. This increases the chance that some of the existing hyperscalers will be among the winners. Of course, that would not prevent stock prices from falling if they overpaid for their infrastructure, for example if returns on investment disappoint, or Chinese competition intensifies, as it did in early 2025.
The more immediate risk may rather be through a few listed and privately owned companies that have taken on leverage far beyond their current capacity, based on expectations of future AI-driven growth. If the monetisation process proves slow, it could lead to financial stresses.
We maintain a moderately pro-risk stance in portfolios
Equities remain in a bull market for now, and we have maintained a moderately pro-risk stance in portfolios. Our global overweight to equities favours emerging markets, where valuations are comparatively lower and growth prospects more attractive. In developed markets, we have a preference for Swiss stocks, where the outlook for the weighty healthcare sector has improved, and Japanese equities that appear positioned to maintain momentum. As we approach the end of 2025, we will assess any adjustments needed to set up portfolios for the year ahead.
The third-quarter earnings season is delivering sound results, but markets are increasingly discerning. Strong corporate results alone are not enough to deliver share price gains as investors look for growth, a clear path to monetise a firm’s client base, and resilient margins. AI remains the central narrative, but while capex continues to rise, investors are increasingly scrutinising firms’ potential for profits. Corporate fundamentals justify higher valuations but overall, developed market valuations, especially in the US, look too high for complacency.
CIO Office Viewpoint
Strong earnings reflect AI support – and valuation concerns
share.