Markets Brief: Patient Investors Rewarded in Earnings Season

US Stock Profits Better Than Expected After Earnings

Despite the Morningstar US Market Index rising 2.3% last week, it continues to trade near fair value and so can be expected to offer average long-term returns. While prices and fair values typically converge over time, this current convergence is unusual as it has been primarily driven by an increase in fair value, triggered by better-than-expected results, rather than a change in price.

With only a few companies left to report this earnings season, FactSet estimates that profits in the second quarter will have risen by 11.8% over the previous year, a significant increase on the initial estimate of 4.9%. This reflects the uncertain impact of US tariffs on companies’ profits over the short term, and also reminds us that the value of companies typically increases over the longer term. As a result, investing tends to favor patient optimists over impatient pessimists.

Tech Stocks Versus the Rest

While the average price of stocks is in line with Morningstar’s estimates of fair value, large gaps in valuations are evident at a more granular level. Fast-growing, technology-enabled companies remain expensive, while stocks in traditional industries remain unloved and consequently could offer higher-than-usual returns. This difference is especially stark among smaller companies and provides opportunities for investors willing to look beyond the main constituents of benchmark indexes and the passive funds that follow them.

However, the patience needed should not be underestimated. As Morningstar’s recent US Active/Passive Barometer report shows, most US active funds continue to trail their passive peers. To find out more about the opportunities Morningstar analysts are seeing, check out this recent market outlook webinar hosted by Morningstar’s CEO, Kunal Kapoor.

Global Trade Tariffs Back on the Agenda

Trade is likely to be back in the headlines this week as the current agreement between the US and China is due to expire on Tuesday. While it seems likely that this agreement will be extended, failure to do so may spook investors and move asset prices, at a time when thin trading can produce unusual market movements.

At the sector level, the disruption caused by rapid changes in US trade policy has been felt acutely by investors in healthcare stocks, which have delivered the worst returns over the year to date, down 4%, and are currently priced at an 11% discount to fair value. Karen Andersen, Morningstar’s director of healthcare company research, discusses the implications of the latest US policy announcements on biopharma companies here.

While investors appear to have become inured to most tariff announcements, their ability to cause disruption was evident in the gold market last week, as gold futures spiked to record highs, amplifying the gap between futures and the price of physical gold. This followed news that the US has imposed tariffs on imports of one-kilo gold bars from Switzerland. Although the White House has promised to clarify the situation with a new executive order, it is a reminder of the challenges that companies face in managing global supply chains, and the potential impact of this friction on longer-term growth rates.

Pension Investors Embrace New Frontiers

The executive order was also the chosen tool for enabling 401(k) plans to provide access to alternative assets, including private funds and cryptocurrencies. Hal Ratner, head of research for Morningstar’s retirement business, unpacks the implications of these changes here.

While greater investment flexibility is always welcome, these new strategies and asset classes present significant challenges for investors as they can increase cost, reduce flexibility, and may not deliver the returns sought. Investors should consider these new options like an all-you-can-eat buffet—simply because something is available does not necessarily mean it should be added to your plate.

Emerging Markets Offer Greater Upside

The Morningstar Developed Markets ex-US Index rose 2.9% and the Morningstar Emerging Markets Index ticked up 2.2% over the week. Despite delivering higher returns over the year to date, with Developed Markets up 21.6% and Emerging Markets up 17%, Morningstar researchers continue to see more attractive opportunities in these markets than in the US, reinforcing the benefits of international diversification. You can access Morningstar’s views on key markets in our latest Global Convictions report.

Following weak employment data at the start of the month and economic growth flattered by falling imports, investors appear confident of a rate cut at the September Federal Reserve meeting and at least one further quarter-point cut before the end of the year; a narrative that is being encouraged by ongoing pressure on rate setters from President Donald Trump.

This narrative will be tested this week when the latest Consumer Price Index inflation data is released on Tuesday. The core measure, which excludes volatile food and energy prices, is expected to have risen by 3% year over year. Any significant deviation from this outcome is likely to cause investors to revise their assessment of future rate cuts. You can find a preview of the report here and keep on top of all the forthcoming economic announcements with this calendar.