Solid earnings growth, despite choppy equity markets

Despite recent market volatility, robust corporate earnings continue to underpin our positive view on equities. We explore earnings dynamics and our sector and regional preferences.

Since early July, global equity markets have been turbulent. They ended the month broadly flat, despite the fact that corporate earnings are on track for another strong quarter. The energy and financials sectors and non-AI companies have outperformed as market returns broaden beyond the technology sector. At the same time, the Middle East conflict, higher oil prices, uncertainty around US monetary policy and US midterm elections have all weighed on market sentiment.

Concerns about the sustainability of investments in artificial intelligence (AI) have also resurfaced, with investors again questioning the returns these will ultimately generate. These concerns have been fuelled by evidence of greater competition from Chinese technology companies, by hyperscalers’ free cash flow turning negative due to fast-rising spending, and by renewed attention to AI firms financing each other's deals. As a result, many equity markets struggled to gain ground in July. For large US companies, beating second quarter (Q2) earnings expectations alone has not been enough to drive share price outperformance. In Europe, the share prices of firms missing analysts’ earnings expectations have been heavily penalised. That suggests more volatility lies ahead in this earnings season.

Nevertheless, underlying corporate fundamentals remain strong and earnings growth is accelerating from already high levels. Analysts lifted Q2 estimates for S&P 500 firms by more than 3% ahead of this earnings season, compared with a more usual 2-3% downward revision. Second quarter results have so far exceeded expectations, despite this high threshold. With around two-thirds of companies having reported, earnings for companies in the MSCI World index are on track to grow around 38% year-on-year. While one-off investment mark-ups contributed to these strong numbers, underlying operating performance remains very solid. In the US, S&P 500 companies grew underlying earnings close to 30% on average in Q2,driven by 11% revenue growth, and strong margin expansion.

Corporate fundamentals remain strong and earnings growth is accelerating from already high levels

AI still drives earnings growth

Technology companies are still powering earnings growth globally as AI investment continues to accelerate. For the first time, capital spending is expected to exceed US hyperscalers’ operating cash flow, or the cash generated by core business operations. Even so, these companies’ operating cash flow growth remains in the mid-30% range, their leverage levels are still generally low and AI monetisation continues to progress.

Cloud revenue growth is still accelerating, with margins reaching new highs, while longer order backlogs give visibility on future earnings. Importantly, enterprise adoption of AI is gaining momentum. Evidence includes a sharp increase in paid Microsoft Copilot subscriptions and reports from ServiceNow, a US software firm, that the number of customers deploying agentic AI solutions has increased ninefold over the past nine months. These developments help alleviate concerns about the sustainability of AI investments.

Enterprise adoption of AI is gaining momentum

Gains for semiconductor manufacturers and commodities have also been an important tailwind for some large emerging markets. Annual earnings growth for the MSCI Emerging Market index is on track to exceed 50%, driven by South Korea, Taiwan and South Africa. This has helped to offset weakness in India, Indonesia and the United Arab Emirates.

Indeed, South Korea has been the most prominent contributor to emerging market earnings growth, driven by the country's leading memory chip producers. While the sector recently experienced a sharp correction amid the unwinding of leveraged investor positioning, thin summer liquidity, and sentiment-related pressures, underlying fundamentals remain supportive. The memory chip market is expected to remain tight for the foreseeable future, while earnings expectations continue to rise. This contrasts sharply with record-low valuations that appear too depressed relative to the strength of the underlying AI infrastructure cycle.

Meanwhile, in Japan, AI-related companies account for around half of the total 35% growth in earnings year-on-year, helped also by an improving macroeconomic backdrop and a weaker yen.

In Europe, earnings growth is weaker, at around 13%, or about 3% above consensus estimates. This reflects less exposure to AI, headwinds from a stronger euro, and the autos sector suffering from rising Chinese competition and weak Chinese demand. Energy contributed around three-fifths of this earnings growth, with additional support from industrials, technology and financials. In the UK, earnings are growing around 35%, with the energy sector responsible for roughly three quarters of this total.

Financials, materials and utilities as profit drivers

At the sector level, financials and energy have joined AI as important profit drivers. Energy firms’ profits have received a short-term boost from the rise in oil prices linked to the Middle East. Earnings growth for the financial sector looks more durable. Here, second quarter earnings materially exceeded expectations, supported by strong loan growth, capital market activity and robust net interest income. We expect this momentum to remain solid, with gradual AI-driven productivity gains adding to the tailwind.

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We also like the materials and utilities sectors, which provide exposure to AI, electrification, and wider industrial spending. In materials, demand for the metals such as copper and aluminium needed for the energy transition is driving strong earnings growth. The Middle East conflict has also created a temporary earnings tailwind for parts of the chemicals industry; higher oil prices have lifted plastics prices while relatively stable US natural gas prices, an important input cost for chemicals, have boosted profitability.

In materials, demand for the metals such as copper and aluminium needed for the energy transition is driving strong earnings growth

Indeed, earnings growth globally remains broad-based across all sectors except healthcare. Here, underlying earnings growth is positive, but was weighed down in the second quarter by one-off merger and acquisition-related accounting charges. We continue to favour the healthcare sector’s improving earnings momentum, which in the US is supported by potential Medicare coverage for obesity drugs, a cyclical rebound in medical equipment, innovation in obesity, oncology and immunology, and easing pricing headwinds.

Watching US consumer spending and jobs

There were some notes of caution in Q2 results. Mentions of layoffs during large US firms’ earnings calls increased modestly, while several firms noted continued consumer caution and greater cost awareness.

We expect periods of volatility to persist

Yet overall, US consumer spending remained resilient over the three-month period, while capital spending continues to gain momentum. Investment is increasingly extending beyond the technology sector and generating positive spillovers, for example in industrial sectors such as freight and logistics, construction and engineering. Consensus analyst forecasts point to an acceleration from 33% growth in capital spending for S&P 500 companies in the first quarter year-on-year to nearly 40% in Q2.

Company guidance also points to continued earnings strength over the coming quarters. Consensus earnings growth for the MSCI World is expected to remain near 20%, and for emerging markets in the 40-70% range. This is then forecast to ease towards mid-2027.

Overall, we remain positive on global equities, with an overweight exposure expressed largely via emerging markets, and a positive view on Japan and on the healthcare, materials, financials and utilities sectors. While robust earnings growth remains the primary driver of our constructive outlook, recent market volatility shows investors continue to scrutinise both AI-related investment and corporate execution. Meanwhile, uncertainty persists over geopolitical developments and the path of US interest rates, putting downward pressure on valuations. We therefore expect periods of volatility to persist, but see broad earnings growth across sectors and regions offering a supportive outlook for global equity returns over the coming quarters.