Markets seem expensive: What do the numbers say?

As markets continued to new highs this year, the increases have made some investors nervous about a possible bubble.

The nerves are understandable, considering the amount of excitement around AI while a lot about its capabilities remains unclear. However, when we look at the numbers across most major markets, share price growth in the last year has been supported by rising earnings, rather than indiscriminate valuation expansion (see table below).

This is a different to the late 1990s, where the dotcom bubble was characterised by a sharp rerating of future growth expectations, with valuations expanding far faster than realised earnings. Today’s market is not valuation-cheap, particularly in the US, but the bulk of returns have been underpinned by stronger earnings. Investors have been paying up for growth, but they have also been receiving growth. 

The strongest earnings momentum remains in the US, Emerging markets and Asia Pacific, as seen in the dashboard below. Emerging markets earnings in Asia look especially strong in companies focussed on the AI hardware cycle. Korea and Taiwan have stood out in recent months within EM. Taiwan’s earnings strength, for example, is heavily linked to advanced semiconductor manufacturing (mostly from Taiwan Semiconductor Manufacturing Company - TSMC), led by demand for leading-edge logic chips from the US large cap tech firms. Meanwhile, Korea has also benefited from the rebound in memory pricing and the surge in high-bandwidth memory demand, where its large chipmakers such as Samsung and SK Hynix are globally dominant. These markets are narrow, but the earnings impulse is powerful, with the AI build-out flowing directly into exports, revenues, margins and upgrades across Emerging markets (see chart below). 

In the US, the earnings cycle has been dominated by similar themes surrounding artificial intelligence. Some of the largest tech companies in the US have increased their spending on building out AI capability and data centres, but have also been able to stay largely profitable. Double-digit earnings growth expectations therefore remain, while the wider US market in general has benefited from resilient consumer demand and productivity gains from AI investment. This explains why US equities have continued to compound despite elevated starting valuations, since earnings have done the heavy lifting.

Japan is also robust from an earnings momentum perspective, though for different reasons. Earnings have been helped by corporate governance reform, better capital discipline, rising buybacks, improved return on equity and a reflationary domestic backdrop. A competitive currency has also supported exporters, but the more durable story is improving corporate behaviour and a stronger nominal growth environment. This has meant Japan’s return on investment and company profit margins are improving at rates well above historic average trends in recent months.

In contrast, earnings growth has been slowest in China and the Eurozone. China’s weakness reflects the lingering property downturn, subdued household confidence, deflationary pressure and limited appetite for broad-based fiscal stimulus. Exporters and selected technology firms are performing better, but domestic demand remains too soft to generate a convincing earnings recovery. In the Eurozone, earnings are being held back by weak manufacturing, high energy costs, soft external demand and tighter monetary policy expectations.

Discover the UK stocks with strong earnings momentum

Importantly, earnings revisions have broadly continued to rise despite the Iran war and challenging macro backdrop. This is because analysts have so far treated the shock as a risk to costs and valuations, rather than as a hit to demand. Higher oil prices are pushing up energy sector earnings estimates globally, while the technology companies driving profit growth have generally maintained guidance and margins (see below).

While earnings across the globe look strong for now, there’s always risks that this could change. But for now, those risks haven’t come to fruition. A prolonged Iran conflict could keep oil and gas prices elevated, keeping inflation expectations and bond yields elevated while tightening financial conditions. That would threaten margins, increase the scope for rate hikes and put pressure on equity valuations. Other risks are aplenty, such as rising supply from new IPOs, market concentration, disappointment in AI returns on investment, and tariff uncertainty, to name a few.

However, overall strong current earnings growth suggests equity returns can remain healthy for now, provided profit delivery can expand beyond the AI theme into the broader market. The key is to stay constructive but disciplined: earnings support risk assets, but diversification across regions, sectors and styles remains essential given the wide range of possible macro and geopolitical outcomes.