Equity markets may keep running for another 12-24 months

Europe supported by manufacturing and banks. Recession risk remains distant for the US, with three areas to watch: household indebtedness, demographic contraction and high multiples in the AI sector.

by Alberto Conca, manager of the Zest Quantamental Equity fund
The current stage of the economic cycle shows signs of resilience in both the United States and Europe, but also a few signals that call for careful monitoring. However, the favourable macroeconomic context and the fiscal stimulus still in place could support markets for a further 12–24 months.
The US economy continues to move with solid momentum: the Dallas Fed GDP Now remains steady at around 2.5%, retail sales are still posting positive growth, and the unemployment rate, although slightly higher, remains far from the levels that have historically anticipated a recession. However, the more economically vulnerable households are beginning to struggle to repay debts tied to credit cards and auto loans. Still, the backdrop remains under control, with default rates at historically low levels. On the corporate side, the picture is decidedly more reassuring: despite uncertainty over tariffs and geopolitical tensions, company margins remain at historically high levels, while the Interest Coverage Ratio confirms businesses’ excellent ability to cover interest on debt.
In Europe too, the tone remains constructive. The recovery in the manufacturing sector, led above all by Germany, is becoming more established, while wage growth and consumer confidence continue to show resilience. A mix that helps ease some of the concerns accumulated in recent years. Added to this resilience is the banking sector, now probably one of the strengths of the economic system. The Reserve Coverage Ratio of US banks signals ample reserves relative to expected losses: a cushion large enough to absorb any shocks. European banks show even stronger metrics, helped by the stricter regulatory regime imposed by the ECB.
Over the past few years, all major market industries have benefited from low rates, globalisation, tax breaks and greater energy efficiency. Margin expansion has therefore been broad-based and structural, and has not been confined to technology. There is, however, a long-term dynamic that could weigh on the cycle in the years ahead: demographics. The restrictive policy on illegal immigration adopted by the Trump administration has significantly slowed population growth, and today overall population growth is less than half what it was 15 years ago, at around 0.35% a year, with a negative impact on consumption and the property market: in the states most exposed to the decline in immigration, retail sales are falling and weaker housing demand is cooling rental prices. A knock-on effect that is helping to slow inflation.
As regards technology, according to Empirical Research, artificial intelligence could increase margins for S&P500 companies by about half a percentage point: a positive contribution, but not enough, at least for now, to justify on its own the elevated valuations of companies most exposed to the AI theme, especially considering the high costs and still limited revenues. The market as a whole does not appear excessively overvalued relative to historical series: it is the mega-caps that are particularly stretched, although in recent years they have recorded stronger growth, high margins and robust cash flow. If the cycle were to follow paths similar to the two long positive cycles of 1982–2000 and 1949–1968, there would still be room to move higher over the next 12–24 months, thanks to a favourable macroeconomic context and fiscal stimulus still in place.
The main unknown remains Artificial Intelligence, with tech-sector multiples particularly high, representing the main vulnerability point should investors revise their expectations on AI. Finally, our internal model indicates an implied Equity Risk Premium (ERP) of just 0.09%: in other words, the S&P500 offers an expected 10-year return of around 4.20% a year, very close to the 10-year Treasury (4.11%) but with significantly higher volatility. Yet, despite such a limited risk premium, the macro backdrop and current fiscal policies allow us to remain constructive on equities in the near future.