Key highlights for this quarter
GLOBAL ECONOMY
Firing on three cylinders
The economic drag from the energy shock proved to be less than feared given the offsetting impulse from AI-related capex, and the ability of markets to source oil from reserves (P. 63). The re-opening of the Strait of Hormuz and decline in energy prices should allow for a cyclical uplift in the global economy in the coming quarters. However, while growth may be resilient, so too is inflation (P. 18). Central banks across both developed and emerging markets have been hiking interest rates to control inflation and the risk is that there is more to come (P. 55). Sticky inflation and increasingly hawkish central banks remain the key risk to ending this economic expansion.
ASSET ALLOCATION
Earnings support equities and credit
Taking advantage of the opportunities in equities also requires addressing concentration risks by remaining geographically diversified. AI opportunities have broadened into emerging markets and the fading energy crunch in Europe may add to the earnings outlook (P. 38). Earnings growth remains strong and has kept valuations in check despite the strong run in headline indices. However, continued revenue growth is needed to justify the ever-rising levels of investment in the AI stack. The rise in bond yields creates income in bond markets again. While investors are right to watch inflation and government spending habits, recognizing that some markets are more fiscally prudent and much of this is reflected in prices means more opportunity in defensive assets to balance out a risk-on stance (P. 19).
FIXED INCOME
Income for incomes sake
Better growth and fading inflation should lead to steeper yield curves in government bond markets. Expectations for further tightening in monetary policy this year may have gone too far, creating more value in the short end of yield curves (P. 53). Meanwhile, corporate bonds remain supported despite tight spreads across both investment-grade and high-yield bonds. All-in yields are attractive, and demand is soaking up increasing levels of issuance (P. 60).
EQUITIES
Capturing opportunities, mitigating risks
Equity market leadership continues to rotate as return dispersion across the tech-related segments of the equity market increased in the second quarter, a healthy sign that markets are not in a bubble. However, with many questions about the disruption and distribution of AI across corporate earnings, investors should focus on how to capitalise on the opportunities while guarding against risks by preparing for volatility among the hyperscalers and increased differentiation in performance, investing across the AI supply chain (P. 49), and going global for that exposure (P. 50). While AI is a dominant narrative across global equities, it is worth noting other enduring themes that have been present in the market.
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