The equity rally’s next test of wider participation

AT THE International Monetary Fund (IMF) and World Bank meetings in Bangkok last week, I came away with a clear impression – that the global economy and financial markets have held up far better than many feared.

Energy and food security concerns, elevated public debt burdens and the disruptive questions posed by artificial intelligence continue to dominate discussions, but growth has stayed resilient. This assessment is entirely consistent with the Lombard Odier house view.

The recent rise in bond yields is undoubtedly uncomfortable for equities, but we see no single level at which a bull market automatically ends. A US 10-year yield above 5 per cent raises the hurdle rate for risk assets and increases financing costs, particularly for smaller and more leveraged companies.

But what ultimately matters is why yields are elevated, and whether corporate earnings can continue to grow through them. On that score, the evidence remains supportive.

Consensus expects S&P 500 third-quarter earnings growth of roughly 30 per cent. Positive guidance still outnumbers negative guidance, and sell-side forecasts continue to point towards S&P 500 earnings per share of about US$420 by 2027. This implies low double-digit growth even after a period of multiples compression.

Valuations have already adjusted. The S&P 500 trades near 19 times forward earnings, close to its 10-year average and well below the 22-plus multiples seen earlier in the cycle.

Equities can still make decent returns if...

If earnings continue to rise while valuations compress modestly further, equities can still generate respectable returns. Higher yields, in that sense, act more as a throttle on valuations than a trigger for lower prices.

History offers useful parallels. In 2021, S&P 500 earnings growth more than offset the drag from rising yields, allowing the index to rally even as valuations compressed.

The 2022 sell-off, driven by a sharp derating as rates repriced, was followed by a strong recovery from 2023 to 2024 after earnings growth resumed, even as 10-year yields rose above 4 per cent.

Today’s AI-led investment cycle is different in its drivers, but the broader lesson remains relevant. Higher yields need not end an earnings-driven bull market if profits continue to compound.

There is, however, another increasingly important consideration – breadth. And it is one to watch closely.

Headline performance has been impressive. The S&P 500 has recorded more than two dozen all-time closing highs in 2026 and is up about 12 per cent in the year to date.

Beneath the surface, however, participation has narrowed.

More than 40 per cent of S&P 500 constituents are down for the year. The median stock has gained less than 4 per cent and, in early October, roughly three-quarters of index members traded below their 50-day moving averages.

The earnings picture shows a similar concentration. While aggregate Q3 growth expectations remain strong, a relatively small group of the largest companies accounts for a disproportionate share of both earnings growth and index performance.

As a result, headline earnings figures somewhat overstate the breadth of improvement in the wider market.

These are amber signals worth monitoring. They are not, however, evidence of a structural bear market.

Fundamentals remain the key offset. IT is expected to be the largest contributor of Q3 earnings growth, with energy providing another meaningful boost.

Yet, median stock-level earnings growth remains robust and earnings revisions continue to improve in a broader range of companies than recent price action would suggest.

Narrow market leadership does not automatically imply weak fundamentals.

I would also point out that the story is not exclusively American. European earnings growth expectations of roughly 25 per cent are more broadly distributed in energy, IT, financials, consumer discretionary and industrials, suggesting that underlying corporate resilience extends beyond US mega-cap technology.

The macro backdrop remains broadly supportive. Global bond yields are at multi-decade highs and pressures are visible, particularly in sovereign debt markets.

Yet – in line with the Bangkok meetings – the IMF remains cautiously optimistic that the global economy can continue absorbing shocks, provided yields do not move higher sharply or in a disorderly way.

Against that backdrop, we remain constructive on equities and overweight risk assets. Rising earnings expectations, resilient margins and contained credit spreads remain green lights.

Narrow breadth is an amber light, particularly if it begins to coincide with deteriorating earnings revisions or widening credit spreads.

The key question for investors is no longer whether earnings growth exists, but whether it can broaden and deepen. As long as profits continue to expand and credit conditions remain healthy, narrow breadth should be viewed as a warning light rather than a stop signal.

In my view, Q3 earnings results and the breadth of that growth will be the decisive test.

The writer is chief investment officer for Asia at Lombard Odier