Investor concerns about high valuations persist across major equity markets. The S&P 500, MSCI APAC ex-Japan and a broad number of APAC markets see their price-to-earnings ratio above the long-term average, implying that a lot of good news in profit growth is being reflected.

AI drives earnings growth beyond the U.S.

In our view, these market valuations may be elevated, but to some extent, this is still justified by robust medium-term earnings that should continue to support stock performance.

U.S. equities remain exceptional, underpinned by healthy earnings growth, rapid artificial intelligence (AI) adoption, strong investment and resilient consumers. A weaker U.S. dollar also boosts overseas business earnings when translated back into USD. Year-to-date, although the U.S. may be lagging in terms of market performance, it has been deriving the highest share of its returns from earnings. Tech is the standout, with megacap companies expected to contribute 42% of S&P 500 earnings growth in 3Q25. Hyperscalers have highlighted in recent earnings calls durable AI demand and capex spending, reinforcing the AI trade resilience. Financials and industrials are also set for a strong quarter, with financials benefiting from robust capital markets activity and a steeper yield curve. Profit margins remain near record highs at 13.6%.

While tariffs may pressure margins, provisions in the One Big Beautiful Bill Act (OBBBA)—such as 100% bonus depreciation and accelerated R&D expensing—should reduce 2026 tax liabilities and boost cash flow, benefiting both tech and capital-intensive value sectors. 

Lower rates and buybacks are also boosting U.S. equity returns

U.S. equities have also seen multiple expansion, as lower interest rates make stocks more attractive relative to bonds. Reduced discount rates in valuation models increase the present value of future cash flows. Record S&P 500 buyback announcements further support multiples, with a projected share count reduction of -0.8% in 2025, compared to the 2001–2024 average of 0.2%. This share count reduction is a positive development, as a lower share count, when combined with higher earnings growth, can lead to even higher earnings per share (EPS) for investors. 

AI’s global expansion: Asia’s growing role

Asia is increasingly benefiting from global AI demand. The AI theme is broadening beyond U.S. megacap tech, with supply chain and regional expansion benefiting Asian corporates. Continued AI demand growth in 2026 is likely to drive further earnings per share (EPS) upgrades over the next 6–12 months.

Recent data show that strong AI-related demand in Asia is offsetting manufacturing sector pressures from U.S. tariff uncertainties. August Taiwan trade data revealed a renewed acceleration in tech exports to the U.S., driven by AI-related servers, GPUs and electronics. U.S. tech earnings reports underscore robust AI activity and sustained bookings, positioning Taiwan’s tech sector for further gains. The Korea Composite Stock Price Index (KOSPI) has risen 16% since June, led by tech on expectations of an AI-driven memory upcycle. ASEAN is seeing major AI infrastructure investments and adoption, especially in Malaysian data centers, while Singapore’s strategic focus on AI should attract further innovation.

China’s long-term AI development remains robust, as highlighted in 2Q25 earnings calls. While the U.S. leads in AI innovation, China is rapidly building a self-sustaining ecosystem, supported by policy, research and a strong supply chain. Recent improvements in market sentiment stem from economic and export resilience despite U.S. tariffs. The Trump-Xi meeting on October 30 removed the immediate threat of major tariff hikes, boosting investor confidence as trade tensions ease. 

Corporate governance reforms in Asia

Asian governance reforms present new investment opportunities. Beyond AI, ongoing corporate governance reforms in key Asian markets present long-term investment opportunities. Japan and Korea have made significant progress with reform programs aimed at improving governance and shareholder value. They continue to make smarter use of their cash piles, either returning this cash to investors as dividends or engaging in share buybacks.

Positioning for 2026: Rotation and diversification

Despite expensive valuations, there are reasons to support current market levels. However, portfolio construction should focus on sheltering against uncertainty, volatility and stretched positionings. Reducing concentration is key, and demand for rotation is likely to increase in 2026 as growth momentum slows.

Particularly within Asia Pacific, there is wide valuation dispersion and stock fundamentals across the region, strengthening the case for investors to take an active approach when seeking to rebalance and diversify portfolios.

Investors have started to question the risk of over-investment in AI and whether future returns will match current market expectations. These questions could lead to a divergence in performance at the single stock level. Meanwhile, growing concerns about AI usage, return on invested capital, product roadmaps and competitive intensity may lead to higher risk-off sentiment. Additionally, despite the recent trade truce, the Trump administration may continue to use tariffs as leverage in negotiations, potentially bringing back more market uncertainties and volatility.

In order to diversify, investors should remember that some sectors and areas are less exposed. Value sectors like financials are more service oriented, while utilities are domestically focused. Defensive sectors such as staples and utilities have provided stability during recent volatility, and real estate has cushioned returns with attractive dividends. As economies repatriate supply chains and enhance self-reliance and self-sufficiency, sectors like industrials and materials should benefit.

China equities present abundant high-yield sectors, with energy and financials providing attractive dividend yields, supporting dividend-oriented strategies. Portfolios tilted toward income generation should fare better in volatile markets, benefiting high-dividend names, especially given their relative value in China. Covered call strategies can also help monetize volatility, providing additional income while retaining equity exposure.

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