So far this year, earnings revisions have been so strong that index-level valuations have actually eased
Investing in the global tech boom is an exercise in itself (see The AI investment boom is reshaping stock market winners). Turning to the rest of the investment universe, our base case remains supportive for risk assets: the world avoids an energy crisis, global growth slows gradually rather than falling into recession, earnings hold up, and the artificial intelligence (AI) investment cycle continues to support profits.
Looking through near-term weakness in activity
The Middle East conflict has lifted energy prices and revived volatility across rates, equities, and currencies.
In our base case, however, the conflict remains a manageable shock rather than the start of a broader macro break. Higher energy costs and tighter financial conditions should cool activity, and global growth should show signs of moderation in the coming months. But the slowdown looks more likely to be a temporary downshift than a stall: softer momentum, not an abrupt contraction.
That distinction matters for portfolios. A gradual slowdown can remain compatible with decent returns on risk assets when earnings are resilient and liquidity conditions are not deteriorating sharply. This backdrop should support equities and credit even as cyclical momentum cools and headline inflation stays elevated.
So far this year, earnings revisions have been so strong that index-level valuations have actually eased in many regions despite robust returns (see Exhibits 13 and 14). This fact provides us with further comfort as we enter the second half of the year.
In equities, the tech super cycle and Middle East conflict dominate sentiment
The largest technology investment cycle of our lifetime is still underway, supporting demand, margins and pricing power across the AI and digital infrastructure ecosystem.
As long as tech momentum persists, we see US equities well supported, given AI-related stocks now account for more than 50% of the S&P 500. However, it’s increasingly clear that a key feature of this cycle is that the technology investment boom is no longer US-only. It is broadening into Asia through hardware demand and the supply-chain build-out needed to deliver AI infrastructure at scale. Asian “picks-and-shovels” providers, especially semiconductor and memory producers, are well positioned.
What is interesting, and perhaps concerning, is that we are not yet seeing optimism about AI filter into the earnings expectations of the broader corporate universe. Positive revisions to analysts’ earnings expectations remain concentrated in technology and in energy-related areas due to the oil price surge. Elsewhere, concerns about the economic impact of the Middle East conflict are dominating sentiment, particularly in areas of the market that act as bond-proxies, such as defensives and consumer-facing stocks (see Exhibit 15).
We see scope for this situation to change in the second half of the year. Not least, we expect a normalisation in energy markets to leave only limited scars on the global economy.
Emerging markets should benefit from two macro tailwinds in our base case. First, easing energy prices should reduce the probability of renewed policy tightening in the region. Second, assuming the Federal Reserve (Fed) does not increase interest rates, this reduces the pressure on emerging market central banks to defend currencies through restrictive rates, which improves the environment for duration, supports equity valuations, and allows domestic policy to become less defensive. While not a blanket buy signal across emerging markets, the macro backdrop creates a more constructive foundation for selective exposure where earnings and policy dynamics align.
Within emerging market equities, we remain cautious on the outlook for Chinese stocks. China’s economy remains two-tier: exports and technology-related investment are firmer, while domestic demand remains weak. Private sector confidence has not recovered convincingly, reflecting the prolonged housing downturn and labour-market weakness. Despite the market’s de-rating relative to Asian peers over the past 12 months, we do not see a clear catalyst for a broad re-rating into year-end.
Having outperformed the US in 2025, hopes that Europe could stage another year of outperformance were dented in the first half of the year as investors once again digested the region’s energy vulnerabilities, and tech enthusiasm returned to the fore. In our base case scenario of slowly normalising energy markets, the pressure should ease on sectors affected by fuel and input costs, especially consumer-oriented areas and parts of industrials. Lower energy and logistics costs would be expected to support discretionary spending and improve operating leverage for companies that have absorbed higher costs. Such a rotation would improve market breadth and reduce reliance on a narrow group of winners, which should be beneficial for European stocks.
Of course, whether Europe can keep pace with the US market depends in large part on the global technology story. Structurally, Europe’s sector mix is less exposed to the fastest-growing areas of technology and AI, limiting participation in current earnings momentum relative to markets with deeper tech representation. However, Europe can still perform well, particularly if financials remain strong on the back of a resilient credit cycle and an upward-sloping yield curve, and consumer names recover on the back of falling energy prices.
UK equities continue to offer a differentiated and relatively attractive profile. A weaker pound, on the back of political uncertainty and a less hawkish Bank of England than markets currently expect, supports internationally exposed revenues, while dividend yields, undemanding valuations, and stronger free cash flow generation provide a solid foundation for total returns.
A lot going on in bond land, but a lot is already in the price
Government bond yields have whipped around in the last few months, as perceptions have shifted around both how large and persistent the inflation problem may be, as well as what governments might need to shell out to support their electorates.
More broadly, investors are wary about the structural shift facing the fixed income landscape – with inflation more prevalent and government commitments to fiscal prudence more questionable. Whether investors should still buy government bonds in a world in which government debt is continually rising is one of the most common questions we get asked.
While these concerns are valid, we would argue that much of this ‘bad’ news is in the price. The post-Covid regime is defined by higher demand for capital. Governments are investing in “national resilience”, while corporates are also spending on AI capex and supply-chain resilience. This competition for capital raises the required return for investors, as demonstrated by the rise of nominal and real yields since 2020 (see Exhibit 16).
The urgency to build resilience has intensified this year, but we do not expect bond markets to price materially higher inflation expectations. While we weren’t convinced that the 2022 cost shock would be transitory, we are convinced this time. The risk of second-round wage effects is lower, and central banks can therefore be less hawkish than market pricing currently implies. This environment should support short-dated bonds and lead to steeper yield curves.
Even with a pro-risk stance, government bonds deserve a place in portfolios, with current yields offering downside protection if growth risks re-emerge. While not our base case, if global stock markets are hit by fading tech euphoria, government bonds would offer material portfolio protection (see The risks are clear and so is the protection).
Our strongest duration preference is UK Gilts. The next few months will remain politically challenging as the potential for a leadership challenge, and a shift in policy direction, becomes clearer. However, we suspect that any contender for the leadership will ultimately be fiscally prudent, having learned the lessons of former prime minister Liz Truss not so long ago. Again, we believe a lot of this political risk is now in the price. Moreover, a softer labour market should keep the Bank of England on hold through year-end.
In the eurozone, German Bunds look reasonably valued, with growth likely to soften as energy costs bite. Broad euro government bond spreads provide ample income, though we are more cautious on France, where September budget negotiations and the 2027 presidential election are likely to bring political risk back into focus.
We see more scope for yields to rise in the US and Japan. Market policy-rate expectations are closer to our view, fiscal policy is expansionary with upside risks, and the US growth outlook is stronger.
Corporate credit remains supported despite tight spreads across investment grade and high yield. All-in yields are attractive, and while issuance is picking up, particularly in US investment grade, demand remains resilient. We do not have a strong preference between investment grade, with higher quality and margins, and high yield, with higher carry and shorter duration. Adding risk through equities seems more appealing than credit since earnings growth offers more upside.
In our base case, the Fed doesn’t hike rates. In which case, emerging market debt looks attractive. Emerging market policymakers showed discipline during the 2022 shock, preserving fundamentals across fiscal balances, real policy rates and currency reserves. Local-currency debt appears particularly well positioned, with attractive real yields relative to developed markets. The asset class should therefore benefit from a weaker dollar once energy markets normalise.
Capital on the move
While we broadly expect risk assets to shrug off this latest bout of political concern, we see two lasting features that could have significant investment implications.
The first is the shifting nature of global capital flows and what this means for the US dollar. Despite benefiting recently from temporary ‘energy-haven’ support, we continue to believe that the dollar is on a new downward path, reversing the trend seen over the 15-year period to 2024. During this time, the US attracted substantial global excess savings, supported by favourable yield differentials and a growth advantage (see Exhibits 17 and 18). Looking ahead, narrowing growth and yield differentials would likely accelerate a marginal rotation away from US assets.
The role of official or public sector saving will be part of this global capital rotation. The more chaotic the world becomes politically, the more governments are spending. As mentioned, a less predictable global order increases the need for defence capability, supply-chain resilience, energy security, and commodity stockpiling. The implication is that global spending will be higher and there will be greater willingness to deploy surplus savings into domestic resilience investment and real assets, rather than purely into financial claims on future US income streams.
Concerns about institutional credibility also matter in dictating global capital flows. Lingering questions around Fed independence, for example, may raise the risk premium investors demand. In that environment, a softer dollar becomes an important tailwind for emerging market assets and, to a lesser extent, European equities.
Recent episodes show quite how sensitive markets are to incremental capital flow changes. On Liberation Day, the world did not dump US assets; it simply bought fewer of them. The impact was still meaningful: the dollar fell around 5% in April 2025, equities sold off, and Treasuries failed to provide their usual hedge, with the 10-year yield rising more than 30 basis points before stabilising.
The second key question for investors to consider is how the changing macro backdrop necessitates a different approach to diversification. Currently all this spending is pushing up real growth with only episodic bouts of inflation. If that balance shifts and inflationary concerns become more systemic, then investors will seek protection in assets that ‘can’t be printed’. Infrastructure, transportation assets, and real estate sit at the centre of resilience, supply-chain security, energy security, and domestic capacity building. They also offer a useful hedge in a more inflationary world, with tangible replacement value, long-duration cash flows, and potential inflation linkage through rents, contracts, or regulated returns. For portfolios, real assets are an increasingly important complement to traditional financial assets.
In conclusion, we think markets are right to discount short-term political noise but should pay close attention to how this shifting geopolitical climate is creating structural changes that will have significant investment implications over the medium term.