Q&A for the Quarter Ahead
GLOBAL ECONOMY
Higher for longer or even higher for longer?
Central banks across the globe have steadily been lifting interest rates to combat the last mile in reducing persistent inflation (P.17) back to their preferred target. This isn’t necessarily bad news for the economy or markets as the need to recalibrate monetary policy is partly driven by more robust economic activity, which should support steady earnings. Futures markets suggest more hikes are likely in the months ahead, but the tighten cycle looks relatively shallow (P.49).
FIXED INCOME
Does it pay to invest in core government bonds again?
Yields and income are firmly back in the spotlight and the reliability of cash flow and returns from income-generating bonds front and centre for investors. Yields across the fixed income spectrum have been rising since the start of the year, reflecting expectations of stickier inflation and tighter monetary policy which is lifting core government bond yields. These higher yields offer a greater cushion against capital losses if rates rise further and the highest level of income in many years which is enhancing their appeal (P.50). However, the diversification benefit of bonds is not as strong as it once was making alternative real assets another means to boost income and diversification within a portfolio (P.67).
EQUITIES
Can the AI rally continue?
The returns from many of the artificial intelligence-related companies and industries continue to defy expectations, but the hurdle to continue to beat this performance is rising. Even so the outlook for global shares remains positive and AI is a compelling secular theme for investors (P.31). Both individuals and businesses are weaving AI into their daily routines, driving demand for computing power which in turn means demand for key inputs like semiconductors and memory. However, concerns on bottlenecks that will slow the pace of AI expansion, from safety imposed regulations, opposition to data centres, or access to energy, may act to cool AI enthusiasm There is still plenty of scope for further monetization of AI models, even at current capacity, alternatively Investors might consider expanding into more physical aspects of AI such as robotics (P.46).
ASSET ALLOCATION
Do expected returns still outweigh the risks?
Equites are a nominal asset and steady real economic growth when combined with slightly firmer inflation should mean continued earnings growth that supports equity returns. However, as the cycle matures there is merit in broadening exposure beyond technology, and financials and industrials offer attractive prospects. Opportunities in Europe and Japan are also worth exploring as these markets offer a different sector mix and return drivers (P.35). With rising yields, fixed income is once again appealing, but care is needed on how much duration to add at this point in time (P.48). The global expansion helps keep default rates in check, supporting high-yield corporate debt and emerging market fixed income. Earnings disappointment, central banks that tighten more than priced or another energy shock are all risks that investors should monitor in the coming quarter.
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