Equities
Over the last few months, investors, in general, have been jumping on and off various theme bandwagons. The result is the stock market has experienced some pretty rapid theme reversals. Here are the various themes and stock responses. Theme 1: “Artificial Intelligence (AI) is great and will drive prosperity for many industries.” When investors embrace theme 1, it is very good for many information technology industries. The theme has been strongly supported by recent earnings announcements. Theme 2: “Tech companies are borrowing and investing too much in AI infrastructure and will lose money and potentially cause a recession.” When investors embrace theme 2, it is bad for technology stocks. We don’t find any evidence to support theme 2. Theme 3: “The Federal Reserve (Fed) will raise the Federal Funds rate and tighten monetary policy to fight inflation.” When investors focus on this theme, it’s bad for economically sensitive, cyclical industries and small-caps. Theme 4: “The Fed will not have to tighten because oil has dropped from $120 per barrel to $90 and inflation will decline on its own.” Theme 4 is good for economically sensitive, cyclical industries and small-caps.
Themes 1 and 4 have generally prevailed off the market low of March 30, 2026, but in August of this year themes 2 and 3 seemed to take over. Rather than taking a “top down” guessing approach to themes, let’s see if a “bottom up” earnings approach sorts it out. Through August 31, 2026, 1452 of the companies in the S&P 1500 Index have reported quarterly earnings. On average, they have beaten estimates by 25.0%. Sectors that beat estimates by the most are Communications 95.9%, Consumer Discretionary 73.5%, Healthcare 18.5%, Technology 11.0%, and Energy 10.4%. We attribute the fact that companies are earning more than analysts expected to two factors. Companies are using AI to increase efficiency and profit margins more than analysts expected. Additionally, the war in Iran and higher interest rates have not affected spending as analysts may have thought.
More impressive than beating estimates is the year-over-year growth in earnings. On average, the 1452 companies that posted earnings are 48.5% greater than a year ago. Sectors leading the growth surge were Energy 139.8%, Communications 112.4%, Consumer Discretionary 81.1%, Technology 72.2%, and Materials 41.2%. As earnings, as well as growth in earnings, are two important components of the ICON valuation equation; ICON valuations, in general, are also growing. We see stock prices as just trying to catch up to valuations.
As for themes, these earnings show why the combination of theme 1 and theme 4 prevailed off the low of March 30. We would also expect the recent adoption among many investors of themes 2 and 3 will prove temporary.
Bonds
The Fed tightened monetary policy in late 2022 and early 2023 to fight the inflation that evolved out of pandemic supply chain problems and recession fighting fiscal and monetary stimulus. The tightening was successful as inflation dropped quickly to the 3% range. It was gradually heading toward the Fed’s target range of 2% until the Iranian attack and the increase in the price of oil. With this recent bump in inflation, the yield on the 10-year Treasury has risen from near 4% in late February of this year to 4.75%, the upper part of its three-year range. We don’t see much more upward pressure on the yield.
Summary
We can see a survey of analysts who predict corporate earnings. They offer estimates for one, two, and in most cases three years out. We are seeing upward revisions that suggest the boom from AI and rapid technological change is much broader than just a select group of technology companies. We are seeing upward revisions in earnings for industries such as construction, investment banking, commercial banking, employment services, educational services, and building materials, among others. We can find value in companies in a position to grow earnings. We like owning them.
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The data quoted represents past performance, which is no guarantee of future results. Opinions and forecasts regarding sectors, industries, companies, countries and/or themes, and portfolio composition and holdings, are all subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security, industry, or sector.
Investing in securities involves inherent risks, including the risk that you can lose the value of your investment. An investment concentrated in sectors and industries may involve greater risk and volatility than a more diversified investment. Investments in international securities may entail unique risks, including political, market, regulatory, and currency risks. In general, there is less governmental supervision of foreign stock exchanges and securities brokers and issuers. Investing in fixed-income securities such as bonds involves interest rate risk. When interest rates rise, the value of fixed-income securities generally decreases.
Individual account holdings and composition may vary. Opinions and forecasts regarding sectors, industries, companies, countries and/or themes, and portfolio composition and holdings, are all subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security, industry, or sector.
ICON’s value-based investing model is an analytical, quantitative approach to investing that employs various factors, including projected earnings growth estimates and bond yields, in an effort to determine whether securities are over- or underpriced relative to ICON’s estimates of their intrinsic value. ICON’s value approach involves forward-looking statements and assumptions based on judgments and projections that are neither predictive nor guarantees of future results. Value readings are contingent on several variables, including, without limitation, earnings, growth estimates, interest rates, and overall market conditions. Although valuation readings serve as guidelines for our investment decisions, we retain the discretion to buy and sell securities that fall beyond these guidelines as needed. Value investing involves risks and uncertainties and does not guarantee better performance or lower costs than other investment methodologies.
ICON’s value-to-price ratio is a ratio of the intrinsic value, as calculated using ICON’s proprietary valuation methodology, of a broad range of domestic and international securities within ICON’s system as compared to the current market price of those securities. According to our methodology, a V/P reading of 1.00 indicates stocks are priced at intrinsic value. We believe stocks with a V/P reading below 1.00 are overvalued, while stocks with a V/P reading above 1.00 are undervalued. For example, we interpret a V/P reading of 1.15 to mean that for every $1.00 of market value, there is $1.15 of intrinsic value which has not yet been realized in the market price.
The unmanaged Standard & Poor’s Composite 1500 (S&P 1500) Index is a broad-based capitalization-weighted index comprising 1,500 stocks of Large-cap, Mid-cap, and Small-cap U.S. companies.
EPS: Earnings from ongoing operations; earnings per share equals total earnings divided by the number of shares outstanding.
The 10-year yield is the benchmark 10-year yield to maturity reflected by the current issue 10-year U.S. Treasury note.
Sources: Bloomberg
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