Global equity markets continue to hit new all-time highs, yet the core rationale supporting this bull run has exhibited a rare divergence from traditional macroeconomic fundamentals. A recent report from Bank of America Securities cautions that the market is pricing a structural leap in corporate profit margins, driven by the AI revolution, as an almost certain base case. The realization of this expectation, however, still hinges on multiple stringent conditions aligning simultaneously. The 12-month forward earnings per share (EPS) for the MSCI World Index has risen 9% over the past three months, equivalent to an annualized increase of nearly 40%, marking the strongest surge since 2021. The three-month EPS momentum for the US S&P 500 Index has climbed to 12%, a 40-year high. Historically, such a reading typically only appears during phases of robust economic recovery from recession. The anomaly of this profit strength lies in the fact that the global PMI has fallen to a two-year low of approximately 50.5. According to historical patterns, this should correspond to flat or even downward EPS revisions. Bank of America data shows that about two-thirds of the EPS upgrades in Europe and globally over the past three months stem from improved margin expectations. The 12-month forward consensus profit margins for both Europe and the world have reached new historical highs, at 13.9% and 11.4% respectively.
According to reports, Bank of America's strategy team likens this phenomenon to the historic impact of China's accession to the World Trade Organization on corporate profitability. At that time, over one billion Chinese laborers entered the global market, significantly weakening the bargaining power of workers in developed nations. This propelled the share of corporate after-tax profits in GDP from 5%-8% to 10%-12%, subsequently maintaining this share at a higher level. Today, the large-scale deployment of AI tools may impact the bargaining power of white-collar workers in a similar fashion, enabling companies to replace human labor with lower-cost AI, thereby capturing a larger share of national income. However, Bank of America Securities maintains a reserved stance on this narrative, upholding its negative rating on European equities. The institution argues that the market currently views the ideal scenario of "unimpeded demand and record-breaking profits" as the baseline, while multiple downside risks are being systematically underestimated, and upside risks are already overpriced.
Profit Expectations Hit Record Highs, Decoupling from Macro Indicators
Global stock markets reached new record highs this week, with year-to-date gains expanding to 9%. According to a European equity strategy report released by Bank of America Securities on May 29th, this rally is driven by three main factors: heightened expectations for a US-Iran peace agreement pushing Brent crude to a one-month low of $93 per barrel, continued resilience in global macro data, and a significant jump in corporate profit expectations. For the full year, 12-month forward EPS expectations for Europe, the US, and the world have risen by 8%, 15%, and 11% respectively, while corresponding stock price gains are 6%, 10%, and 9%. This indicates that the year-to-date equity gains are entirely supported by earnings growth, with valuation multiples actually experiencing a slight decline.
Yet, this EPS uptrend exhibits clear anomalies. Historically, EPS momentum is highly correlated with the global composite PMI new orders index. However, the current global PMI continues to slide to a two-year low around 50.5. Based on historical experience, this should correspond to flat or even downward EPS revisions, yet the market is moving contrary to this trend. In Europe, where profit performance traditionally lags, the three-month increase in 12-month forward EPS has also reached 7%, the strongest since 2021. More crucially, the core driver of this EPS upgrade is the expansion of margin expectations, not sales growth. Since 2022, margin expectations have consistently exceeded the levels implied by the historical relationship with the global macro cycle, and the magnitude of this overperformance is widening. Currently, the 12-month forward consensus profit margin for Europe stands at 13.9%, and globally at 11.4%, both at record highs since data collection began. Concurrently, the 3-year forward annualized EPS growth rate has climbed to a five-year high of 16%, indicating market consensus firmly believes the current high margins will be sustained.
"AI Effect Similar to China's WTO Entry": Market Bets on Structural Margin Leap
Regarding this anomalous phenomenon, Bank of America Securities strategists offer an interpretative framework with significant historical depth. The report points out that the starting point for margin expectations surpassing macro logic closely aligns with the launch of ChatGPT in late 2022. The most compelling explanation is that the market is pricing in a structural improvement in corporate profitability driven by the AI revolution. The historical precedent for this logic is China's accession to the WTO in 2001. At that time, China's entry introduced over a billion laborers into the global economy, drastically reducing the bargaining power of workers in developed nations. This pushed the share of labor compensation in GDP for US non-financial corporations down from a historically stable range of 61%-65% to a lower range of 57%-60%. Simultaneously, the share of corporate after-tax profits in GDP leaped from the 5%-8% range to 10%-12%, and has since remained at this elevated level.
The report posits that the large-scale deployment of AI tools may have a similar effect on white-collar workers—just as external competition around the turn of the century disrupted blue-collar employment markets, AI competition may further erode the bargaining power of white-collar workers. This would allow companies to replace human capital with cheaper AI, enabling another structural upward shift in profit margins without requiring a macroeconomic acceleration. At the valuation level, this logic is also corroborated by market signals: the US stock market capitalization-to-GDP ratio recently hit a record high of 225%, and the global market cap-to-GDP ratio also reached 105% for the first time. Bank of America suggests that if corporations indeed succeed in capturing a larger share of the economy, the intrinsic value of equity assets relative to the overall economic scale should correspondingly increase. It is worth emphasizing that this is not merely a technology sector phenomenon. Excluding tech stocks, the 12-month forward consensus profit margin for the MSCI World Index has also risen to a record high of 12%. Meanwhile, tech stocks are projected to contribute 23% of global corporate profits over the next 12 months, also a historical record. Of course, Bank of America also notes an alternative interpretation: historically, in the early stages of every large-scale corporate investment boom, a temporary margin expansion occurs driven by capacity scarcity and robust demand. Subsequently, as depreciation climbs and supply expands, margins often recede. This pattern of "boom-bubble-burst" is evident in the railway boom of the 1880s, the radio boom of the 1920s, and the tech boom of the 1990s.
Five Hurdles: Risks on the Path to a "Golden Age of Corporate Profits"
Bank of America Securities emphasizes that the vision of a "golden age of corporate profits" is not logically impossible. However, transitioning from an ideal scenario to reality requires numerous conditions to align simultaneously, currently facing at least five potential obstacles: First, exogenous macro downside risks. EPS momentum has exceeded levels historically implied by the PMI but is unlikely to completely decouple. Global oil inventories are tightening. The Brookings Institution estimates that if energy flows through the Strait of Hormuz are not restored promptly, a new supply-demand balance would be forced through demand destruction. Prediction markets currently price the probability of the Strait returning to normal by early July at only about 34%, and by early August at about 55%. Concurrently, Bank of America economists note that the growth rate of US consumer real income has fallen to recessionary levels, and the fiscal stimulus that previously supported consumption is depleting. Second, endogenous macro downside risks. The core premise of the AI-labor substitution narrative is that companies replace human labor with AI. However, if multiple firms simultaneously reduce hiring, it could further weaken an already fragile labor market, creating a scenario akin to Keynes's "Paradox of Thrift." Bank of America data shows that the three-month nonfarm payroll growth rate in the US remains near zero, a level historically highly correlated with economic recessions. The report also points out that the proportion of AI-related layoff announcements has recently surged to a new high. Third, rising AI usage costs. According to data, the cost of AI large language model token usage has doubled year-to-date. Reasons include major model providers cutting subsidies ahead of IPOs, the rise of agentic AI increasing token consumption, and rising energy costs. Bank of America has observed some companies scaling back AI usage due to rising costs. If this trend continues, it would undermine the core assumption of AI's economic viability as a labor substitute. Fourth, uncertainty in the productivity improvement timeline. Current market pricing implies an immediate return on AI for corporate productivity. However, Bank of America economists' bottom-up calculations suggest AI currently contributes about 0.1 percentage points annually to productivity growth, with full effects potentially taking a decade to materialize. This creates a clear disconnect with the market's expectation of an immediate profit leap. Fifth, political risk. Even if large-scale AI replacement of white-collar workers does not cause significant labor market disruption, it could trigger a larger political backlash, increasing political pressure to levy windfall taxes on successful tech companies—similar to how the loss of blue-collar jobs fueled the populist wave from the 2010s to the 2020s. The report cites recent calls in South Korea for a "national dividend" funded by AI profits as an early signal of this political pressure.
Bank of America Maintains Negative European Equity Rating, Advises Underweighting Cyclicals
Based on the above comprehensive assessment, Bank of America Securities maintains its overall negative rating on European equities, forecasting approximately a 10% downside for the Stoxx 600 by the end of the third quarter, with a target of 560 points, and a year-end target of 590. Bank of America's core argument is that the market currently overestimates the achievable probability of an AI-driven structural margin leap while underestimating the risk of demand destruction triggered by an energy shock. The Stoxx 600's equity risk premium currently stands at 4.6%, only 10 basis points above its 20-year low earlier this year. Market pricing implies a mild recovery in the global PMI, which contradicts the forecasts of Bank of America's macro team. Regarding sector strategy, Bank of America is overweight defensive sectors like food & beverage and pharmaceuticals, as well as quality stocks. It is underweight banks and capital goods, and maintains a negative view on the performance of cyclical stocks relative to defensive stocks. This ratio is currently at a 30-year high, and Bank of America expects about 10% downside potential. Bank of America notes that if its anticipated macro downturn and widening risk premium materialize, this year's profit-driven logic will face a reversal test—then margin expectation downgrades and valuation compression could occur simultaneously. Of course, the institution also acknowledges that if the market's anticipated scenario does materialize—AI efficiency dividends materialize rapidly, macro resilience persists, and the energy crisis dissipates—then the current high margin expectations could be validated. However, Bank of America believes this near-idealized scenario is currently being priced by the market with excessive certainty.
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