SUMMARY
U.S. earnings strength drive equity returns amid overheating. Broadening inflation and strong growth support the case for seeking real asset exposure, with gold and natural resources remaining potential key portfolio diversifiers.
KEY TAKEAWAYS:
U.S. earnings growth, not multiple expansion, drives sustainable returns
Tech earnings serve as bellwether for AI-linked equity momentum
Inflation breadth exceeds pre-COVID norms across consumer & producer measures
Overheating regime supports real asset exposure in portfolios
Gold & natural resources act as long-term diversifiers vs. short trades
Complacent sentiment suggests near-term equity momentum may slow
Earnings drive returns as sentiment and positioning reaches “complacent” levels
Importantly, earnings growth, not multiple expansion, is driving U.S. equity returns.
Roughly 10% of year-to-date U.S. equity gains have come from earnings growth, which we view as a more durable foundation than valuation re-rating alone.
This contrasts with Europe, where 85% of last year’s equity return came from multiple expansion rather than earnings growth, and earnings are growing by only 5.4% so far this year.
European economic growth continues to struggle, and as a net energy importer, we believe the region faces structural headwinds that peers have largely avoided.
Emerging markets (EM) have benefited from the AI buildout.
South Korea recently overtook China in EM Exchange-Traded Fund (ETF) market cap share, with Taiwan also gaining as two critical nodes in the semiconductor supply chain.
Japan has also seen multiple expansion alongside defense spending tailwinds, distinguishing it from most other developed markets this year.
Bottom line: Earnings strength in the U.S. remains the most sustainable driver of equity returns today, but positioning and sentiment indicators suggest that we could see some slowdown in forward momentum.
A U.S. equity sentiment and positioning indicator we utilize recently reached a "complacency" reading.
What does this imply for markets?
Historically, when sentiment and positioning indicators reach a fear reading, this has been a statistically significant contrarian buy signal, with prior instances going back to 2011 producing strong forward returns (see Figure 2 here).
Complacency readings, by contrast, have not been a statistically significant sell signal.
Historically, the complacency reading has instead been followed by rangebound returns, with a bias towards lower-than-normal returns.
Given that long positioning has grown over the past two months, near-term return potential for equities may be more limited from current levels.
Inflation stays broad and sticky as the overheating regime holds
The U.S. economy entered an overheating regime last October, defined by growth and inflation rising above historical trends.
This is distinct from stagflation, which requires growth deterioration alongside elevated price pressures, and we do not currently see evidence of stagnation in the U.S. economy.
Inflation breadth tells a more complete story than headline readings alone.
Currently, 45% of CPI components are rising at a 5% or higher annualized pace, compared to the pre-COVID average of 25%.
In PCE, the Fed's preferred measure of inflation, the latest figure stands at 34%, also well above the pre-COVID baseline.
Looking abroad, outside of COVID, Japan PPI in April rose at the fastest pace in almost eighteen years.
The geopolitical conflict has added pressure to energy prices even as inflation in most major economies was above target.
But growth has remained strong: US same-store sales growth averaged 6.6% year-over-year in January and February and moved even higher after the Middle East conflict began, reflecting a consumer that continues to absorb costs with resilience.
Business pricing expectations offer an important forward signal.
Following the COVID shutdown, businesses largely predicted the inflation surge that followed.
Today, business pricing expectations are moving sideways, which suggests a more nuanced view of price pressure than the surge experienced in 2021.
Recent U.S. inflation data printed on the high side, and we will be closely watching readings for the U.K. and Japan this week.
Bottom line: Inflation remains sticky, and above pre-COVID breadth norms across both CPI and PCE measures.
We continue to position portfolios defensively against persistent and potentially widening price pressure.
Real assets continue to deliver in an overheating environment
Historically, overheating regimes have favored real assets over fixed income, and the current cycle is tracking that pattern closely.
Gold has outperformed fixed income on a one-year basis and is outperforming year to date, consistent with its historical behavior during periods of elevated inflation.
Reviewing gold returns across different inflation regimes going back to 1990, gold has outperformed in virtually all inflationary environments.
We treat gold as a long-term portfolio holding and a substitute for duration, not a short-term tactical position.
Natural resources have delivered strong returns since we initiated a tactical long position in December.
The Morningstar Global Natural Resources Index has returned approximately 23% since the inception of that call on December 9, 2025, outperforming the S&P 500 by roughly 14.5% percentage points over that period.
Real assets as a category have historically outperformed during environments of rising growth and rising inflation, which describes the current regime.
Longer duration Treasuries have historically underperformed in an overheating environment, consistent with our underweight duration.
This reinforces the case for real asset substitutes that can absorb inflation pressure rather than erode under it.
Bottom line: We continue to favor gold and natural resources as portfolio diversifiers suited to the current overheating regime.
We view both as longer-term allocations rather than near-term trades and expect them to remain relevant as long as inflation stays elevated.
