Expectations for solid corporate earnings drove our U.S. and Japanese equity overweights this year. They have delivered, showing that fundamentals are key. Earnings strength could matter more to equity investors in 2025 over valuations. By contrast, European earnings growth remains soft due to stagnant economic activity. We get granular to find opportunities – like in European financials. We see U.S. earnings strength broadening, largely on the artificial intelligence (AI) theme.
U.S. leads the way
12-month trailing and forward earnings expectations for U.S. versus rest of world
Coming into 2024, we favored U.S. and Japanese equities because we expected them to deliver the strongest earnings growth. Both delivered. The U.S. has posted 9% earnings growth in the last 12 months compared with just 1% for the rest of the world, LSEG Datastream data shows. See the chart. U.S. stocks have soared on the AI theme and resilient economic growth. The earnings of “magnificent seven” mostly tech companies have surged 45% in the past year. Japanese companies have achieved 14% earnings growth in yen terms on shareholder-friendly corporate reforms plus the return of mild inflation helping drive corporate pricing power. Consensus expectations are for the U.S. to keep leading on earnings even as they are seen improving globally. We think this varied performance shows why this is not a typical business cycle – and why themes like AI and granular views matter more.
Can earnings meet high consensus expectations in 2025? Even if forecasts come down over the course of the year as they tend to, we expect broad-based earnings growth as regions outside the U.S. improve from a low base – but stick with our preferences. In the U.S., the magnificent seven are still expected to drive earnings on the AI mega force – a big, structural shift. Yet their lead should narrow as easing inflation, resilient consumer spending and the prospect of looser regulation fuels sectors beyond tech. As the AI buildout progresses, it creates investment opportunities – and earnings growth potential – in the utilities, industrials, energy and real estate companies providing key AI inputs. We stay overweight U.S. equities as we think risk-on sentiment can persist thanks to the prospect of corporate tax cuts and deregulation.
Japan's positive outlook
Japan is another bright spot – and its broad earnings growth has even outpaced the U.S. over the past year. A sunnier macro picture due to inflation’s return and shareholder-friendly corporate reforms are reasons for optimism. November’s pickup in core inflation is less of a concern given Japan is still only seeing a return of mild inflation. We think a solid domestic outlook can keep driving earnings even as the yen’s pickup from recent lows can be a drag. Japan’s domestic resurgence could also mitigate the hit from threats like rising U.S. protectionism, in our view. We stay overweight Japanese equities as a result.
In regions with a more challenging outlook, getting granular is key. Europe is still struggling, with Q3 marking just its second straight quarter of earnings growth. Earnings for around half of European sectors are still in decline, LSEG Datastream data shows. Yet we eye selective opportunities like financials, the top performing sector due to higher interest rates. We also like European utilities, one of the few non-U.S. AI beneficiaries. In the UK, we went tactically overweight UK equities earlier this year on attractive valuations and political stability following the Labour Party’s landslide victory in the UK election. Yet that hasn’t spurred the renewed investor interest in the country we expected, while earnings in the UK are outright contracting.
Our bottom line
Earnings are delivering on our overweight to U.S. and Japanese equities where we see solid earnings growth holding up. Even with pockets of weakness elsewhere, getting granular reveals opportunities such as in European banks.
Market backdrop
U.S. stocks rose to record highs in holiday-shortened trading last week. European stocks slipped on concerns about the fragile French government losing a confidence vote. The Mexican peso and Canadian dollar fell against the U.S. dollar on worries about potential tariffs. Markets have been moving closer to our view that sticky inflation could limit Fed rate cuts, reinforced by the U.S. PCE data. U.S. 10-year yields hit a one-month low near 4.20%.
The U.S. payrolls report for November is the key release. We watch for whether job growth rebounds from October’s unexpected drop due to weather-related disruptions. The recent path of job creation still supports our view that the labor market remains strong, fueled by elevated immigration. As immigration falls back, we see employment growth dropping to a slower pace than pre-pandemic – reflecting an aging population, rather than weakness in activity.
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