.svg)
Solid outlook
Equity markets continued to advance in September, although the investment environment remains marked by considerable uncertainty. Like the colours of autumn, this year's market outlook presents an unusually broad spectrum of shades and nuances. Rising long-term interest rates, developments in the Strait of Hormuz, the profitability of artificial intelligence investment and the approaching US midterm elections are each shaping the market debate in their own way. Yet amid these themes, strong corporate earnings growth and attractive return prospects continue to provide solid support for equities. We therefore maintain an overweight allocation to equities in our investment recommendations.
US midterm elections could increase market volatility
Investors have had plenty to consider in recent weeks. Higher energy prices, rising interest rates and uncertainty over the profitability of artificial intelligence investment have tempered market optimism. As a result, share prices have not risen as quickly as the outlook for corporate earnings has improved. This caution also has a positive side: a healthy degree of investor scepticism reduces the risk of excesses and market bubbles.
Attention will also turn to the US midterm elections in the coming weeks. Any signs of a shift in the direction of policy could prompt short-term market moves, although midterm elections have not generally altered the longer-term course of equity markets. Even so, investors should be prepared for greater-than-usual volatility around the elections in early November.
The economy remains in robust shape
The global economy has performed more strongly than expected, supporting robust corporate earnings growth. The US economy, in particular, has surprised on the upside. In addition to investment in artificial intelligence and data centres, growth has been driven by private consumption, a recovery in manufacturing and broader corporate investment. Recent confidence indicators also suggest that economic activity in western economies remains firm.
There are, however, sizeable differences between regions. The US is growing considerably faster than Europe, while Asia remains an important engine of the global economy. In Europe, growth is being constrained by weak domestic demand, tight monetary policy and challenges in the industrial sector. Overall, global growth nevertheless appears resilient, even though volatile energy prices and persistently high inflation continue to cloud the outlook.
Corporate earnings provide the strongest support for equities
Corporate earnings growth is exceptionally strong worldwide. Nor is this growth any longer confined to the success of a handful of large technology companies: earnings expectations have improved across a range of sectors and regions.
The earnings season beginning in October will provide the next important test. Earnings growth expectations in the US are substantially stronger than in Europe, and, unusually, analysts have revised their forecasts upwards as the reporting season approaches. Technology and artificial intelligence investment remain key engines of growth, but investors are increasingly focused on how effectively this substantial spending translates into revenue, operating profit and cash flow.
We expect the forthcoming earnings season to reinforce the picture of healthy earnings momentum. Strong and broad-based profit growth remains the principal pillar supporting the equity market rally. Although equity valuations have moderated somewhat, they still leave relatively little room for earnings disappointments.
Central banks continue to tighten monetary policy
Higher energy prices and robust economic growth have once again made price stability a central concern for central banks. Monetary policy has tightened, and markets are pricing in further interest-rate increases towards the end of the year. Interest rates may therefore remain high for longer than was anticipated only a short while ago.
For equity markets, this is reflected above all in larger-than-usual price moves around economic data releases and central bank decisions. Rising interest rates tighten financing conditions for companies and put particular pressure on the valuation multiples of highly valued growth stocks. In the current environment, however, higher rates alone are unlikely to derail the positive trend in equity markets, provided that economic and earnings growth remain strong.
