Why we have become more constructive on equities
August 2026, Asset Allocation
- Key Insights
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- Earnings expectations are exceptionally strong across markets, while recent results, healthy revenue growth, and expanding margins reinforce the equity outlook.
- Valuation multiples have remained broadly stable, suggesting markets are not extrapolating today’s unusually strong earnings growth far into the future.
- Improving global activity, low unemployment, and healthy corporate and household balance sheets suggest recession risks remain below average across regions.
Year-to-date equity returns have been strong, but the S&P 500 has moved largely sideways since early May as investors have weighed elevated geopolitical risks, stubborn inflation, and rapid change surrounding artificial intelligence.
Despite these uncertainties, we believe the setup for equity performance over the next six to eighteen months remains favorable.
The most compelling part of the equity story continues to be earnings.
Forward earnings expectations are exceptionally strong across investment styles, market capitalizations, and geographies. Not surprisingly, areas with the greatest exposure to the ongoing AI infrastructure buildout continue to lead the way. Emerging markets and U.S. large-cap growth stocks are currently expected to deliver earnings growth of approximately 35% and 28% over the next 12 months, respectively.
But perhaps even more encouraging is the breadth of this strength. Areas with much less exposure to AI are also expected to generate double-digit earnings growth.
What's particularly remarkable is that this is not occurring during a recovery from recession. Historically, earnings growth of this magnitude has usually followed periods when profits were severely depressed, making comparisons unusually easy. That is clearly not the case today.
The backward-looking data are equally encouraging. Companies are not only reporting strong earnings growth. Recent results have also come in ahead of earlier expectations. Revenue growth remains healthy, while profit margins continue to expand. In short, earnings fundamentals remain strong across the board.
Admittedly, earnings growth expectations this high have rarely proven sustainable over long periods. However, the unprecedented pace of AI infrastructure spending appears to be supporting these unusually strong fundamentals, and there are few signs that this investment cycle is slowing.
Just as importantly, valuations have remained surprisingly disciplined.
Normally, earnings growth this strong is accompanied by rapidly expanding valuation multiples as investor enthusiasm builds. Instead, price-to-earnings ratios have remained relatively stable despite the sharp increase in earnings expectations.
In fact, the two areas with the strongest expected earnings growth—U.S. large-cap growth and emerging markets—have actually seen their valuation multiples decline modestly.
This suggests investors recognize that today's extraordinary earnings growth is unlikely to persist. Rather than extrapolating current conditions far into the future, markets appear to be assigning reasonable valuations to these unusually strong earnings expectations.
Economic risks remain modest
Finally, the economic backdrop remains supportive.
Most bear markets are ultimately driven by recession. Today, however, economic data suggest recession risks remain below average.
One of the clearest indications comes from purchasing managers' indexes, or PMIs, which provide one of the timeliest measures of global economic activity. PMIs have been improving across much of the world—not only in the United States, but also in Europe and China, where AI infrastructure spending plays a much smaller role in overall economic growth.
This suggests the current expansion is not being driven solely by AI. Economic activity appears to be broadening across industries and regions.
It is also encouraging that many of the conditions that typically make economies vulnerable to recession remain largely absent. Unemployment remains relatively low, while aggregate corporate and household balance sheets continue to appear healthy.
Conclusion
Although the earnings outlook and broader economic backdrop appear robust, uncertainty remains higher than normal.
Geopolitical risks remain elevated, as illustrated by the ongoing conflict in the Middle East and its impact on energy markets and inflation expectations.
At the same time, AI continues to reshape the investment landscape at an extraordinary pace. Advances in AI capabilities, shifting competitive leadership, and rapid adoption are occurring much faster than investors have experienced during previous technological revolutions.
Nevertheless, we believe the combination of exceptionally strong earnings, reasonable valuations, and a supportive economic backdrop creates an attractive environment for equities over the intermediate term.
As a result, our Asset Allocation Committee has recently moved to an overweight position in equities relative to bonds. However, that overweight remains relatively modest, reflecting the elevated uncertainty that still surrounds the outlook.
Outside of the United States, this is intended for investment professionals only. Not for further distribution.
Why we have become more constructive on equities
Year‑to‑date equity returns have been strong, but the S&P 500 has moved largely sideways since early May as investors weigh elevated geopolitical risks, stubborn inflation, and rapid change surrounding artificial intelligence (AI). Despite these uncertainties, we believe the setup for equity performance over the next six to 18 months remains favorable.
The most compelling part of the equity story continues to be earnings.
Expected earnings growth is exceptionally strong
The most compelling part of the equity story continues to be earnings. Forward earnings expectations are exceptionally strong across investment styles, market capitalizations, and geographies. Not surprisingly, areas with the greatest exposure to the ongoing AI infrastructure build‑out continue to lead the way. Emerging markets and U.S. large‑cap growth stocks are currently expected to deliver earnings growth of approximately 35% and 28% over the next 12 months, respectively.
But perhaps even more encouraging is the breadth of this strength. Areas with much less exposure to AI are also expected to generate double‑digit earnings growth. What is particularly remarkable is that this is not occurring during a recovery from recession. Historically, earnings growth of this magnitude has usually followed periods when profits were severely depressed, making comparisons unusually easy. That is clearly not the case today.
The backward‑looking data are equally encouraging. Companies are not only reporting strong earnings growth. Recent results have also come in ahead of earlier expectations. Revenue growth remains healthy, while profit margins have continued to expand. In short, earnings fundamentals have remained strong across the board.
Admittedly, earnings growth expectations this high have rarely proven sustainable over long periods. However, the unprecedented pace of AI infrastructure spending appears to be supporting these unusually strong fundamentals, and there are few signs that this investment cycle is slowing.
Valuations remain reasonable
Just as importantly, valuations have remained surprisingly disciplined. Normally, earnings growth this strong is accompanied by rapidly expanding valuation multiples as investor enthusiasm builds. Instead, price‑to‑earnings ratios have remained relatively stable despite the sharp increase in earnings expectations. In fact, the two areas with the strongest expected earnings growth—U.S. large‑cap growth and emerging markets—have actually seen their valuation multiples decline modestly.
This suggests investors recognize that today’s extraordinary earnings growth is unlikely to persist. Rather than extrapolating current conditions far into the future, markets appear to be assigning reasonable valuations to these unusually strong earnings expectations.
Economic risks remain modest
Finally, the economic backdrop remains supportive. Most bear markets are ultimately driven by recession. Today, however, economic data suggest recession risks remain below average.
One of the clearest indications comes from purchasing managers’ indexes (PMIs), which provide one of the timeliest measures of global economic activity. PMIs have been improving across much of the world—not only in the United States, but also in Europe and China, where AI infrastructure spending plays a much smaller role in overall economic growth.
This suggests the current expansion is not being driven solely by AI. Economic activity appears to be broadening across industries and regions. It is also encouraging that many of the conditions that typically make economies vulnerable to recession remain largely absent. Unemployment remains relatively low, while aggregate corporate and household balance sheets continue to appear healthy.
Conclusion
Although the earnings outlook and broader economic backdrop appear robust, uncertainty remains higher than normal. Geopolitical risks remain elevated, as illustrated by the ongoing conflict in the Middle East and its impact on energy markets and inflation expectations.
At the same time, AI continues to reshape the investment landscape at an extraordinary pace. Advances in AI capabilities, shifting competitive leadership, and rapid adoption are occurring much faster than investors have experienced during previous technological revolutions.
Although the earnings outlook and broader economic backdrop appear robust, uncertainty remains higher than normal.
Nevertheless, we believe the combination of exceptionally strong earnings, reasonable valuations, and a supportive economic backdrop creates an attractive environment for equities over the intermediate term.
As a result, our Asset Allocation Committee has recently moved to an overweight position in equities relative to bonds. However, that overweight remains relatively modest, reflecting the elevated uncertainty that still surrounds the outlook.
Timothy C. Murray, CFA
Capital Markets Strategist
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