What are the three scenarios for how the Middle East conflict could evolve, and what could they mean for investors?

We consider three scenarios of how the conflict in the Middle East could evolve over time. Below, we outline possible scenarios and what they could mean for investors. We continue to view the first scenario—reopening the Strait—as the most likely outcome. An extended blockage of the Strait would shift global economic risk from inflationary to stagflationary. Sustained damage to oil and gas production and infrastructure would also pose a risk of a long-term downgrade in economic growth, while pushing governments to seek more permanent solutions to improve energy independence.

Global AI investment opportunities and risk: Concerns about concentration again?

AI remains a key market theme, but rising index concentration means that broad indices are becoming increasingly directional bets on uninterrupted AI momentum. As of May 18, the Magnificent 7* accounts for 36% of the total market value of the S&P 500, turning it into an increasingly directional bet on uninterrupted AI momentum. However, market leadership within AI is evolving, shifting from hyperscalers to broader sector beneficiaries like semiconductors, equipment makers, and component suppliers, with end-users in sectors like financials and industrials potentially poised to be the next leg of the opportunity. Any revenue miss in technology or communication services could trigger indiscriminate de-risking across the AI-related portfolios. A broader exposure beyond mega-cap leaders to the wider AI ecosystem and region diversification, as well as private markets, may help in reducing the risks associated with concentrated markets.

China: Can AI help drive an equity turnaround?

Offshore China equities have lagged due to softer earnings momentum, weaker flows, a less favorable sector mix, and higher geopolitical sensitivity. A sustained catch-up likely requires domestic demand stabilization, easing platform competition, AI monetization, and policy follow-through. Large Chinese platforms are seen as being in a "heavy investment, light return" phase: AI capex and R&D are rising, but monetization through advertising, cloud, and AI applications has not yet accelerated enough to support a re-rating. A more constructive setup could emerge if AI investment begins translating into revenue growth, profit margin support, or new product adoption.

How does a change in Congress after the mid-term elections change U.S. policies?

A divided Congress would make it more difficult for the president to advance legislative priorities, especially on fiscal policy. If Democrats take control of the House, even this budget reconciliation route becomes more challenging. With legislative avenues constrained, the administration is likely to rely more heavily on executive powers. Tariffs, regulation enforcement, and foreign policy are areas where the administration could still make an impact without collaborating with Congress.

How do central banks balance between inflation and growth challenges after an energy shock?

The key differentiator for monetary policy will likely be how each central bank balances upside inflation risks against downside risks to growth. Softer underlying growth in the U.S. offers room for the Fed to stay put, while the ECB and the BoE may adopt a more proactive approach in pre-empting inflation risk. The Bank of Japan (BoJ) should remain on a policy normalization path, albeit with delays, while divergence in Asian interest rates is expected to widen ahead. With wide differences in domestic economic conditions and central bank reaction functions, interest rate paths are likely to diverge further in the coming months.

Will Value outperform Growth, and what conditions could help Value stocks shine?

Value has outperformed Growth outside the U.S. this year while the U.S. has stayed more Growth-led, making style performance more regional and driven by inflation/rates amid geopolitical disruption. Persistent sell-offs in long-dated sovereign bonds, notably in Japan and the U.S., are consistent with markets repricing toward a longer-lasting inflation/high-rate environment. That matters because higher and more volatile rates tend to be bad news for Growth stocks, which prefer lower rates for easier debt servicing and the ability to finance expansion cheaper. Growth can still win when earnings delivery is strong enough and when investors are willing to pay for long runway business models.

<p>Mid-Year Outlook 2026</p>

Q: Why are alternatives becoming “the new diversification” in an inflationary world?

The macro environment in 2026 has shifted, with the threat of elevated inflation and fiscal imbalances driving a positive stock-bond correlation and altering portfolio risk profiles. Alternative assets offer characteristics that can replicate or complement public market exposures, benefiting portfolios through low mark-to-market volatility and reduced correlation to public assets. Alternative assets, private equity, private credit, and infrastructure —offer return and diversification benefits through lower volatility and reduced correlation with public markets. Private market assets should be viewed as a complement, not a replacement, to public market assets in a portfolio.

Don’t park the bus

As we approach the football World Cup, some teams could be accused of “parking the bus,” a passive strategy to put most players in front of the goal to avoid losing.

There are plenty of uncertainties facing the global economy. We have the ongoing conflict in the Middle East, potential central banks’ response to a return of inflation, possible shifts in the U.S. political and policy backdrop, and the rapidly changing landscape in AI (artificial intelligence) development. With a broad range of assets on our team sheets, being passive and hiding behind cash¹ is not the right strategy.

In our 2026 Mid-Year Outlook, we discuss a number of key market questions and what that means for investors.

How could the Middle East conflict evolve?
Global AI investment opportunities and risks: Concerns about concentration again?
China: Can AI help drive an equity turnaround?
Mid-term elections: How does a change in Congress change U.S. policies?
Central bank policy: How to balance between inflation and growth challenges?
The new diversification: Alternatives in an inflationary world
Value vs. Growth: Value to shine?

¹Cash proxied by U.S. short-term Treasuries.

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Developments in the Middle East remain the key determinant of economic and market performance in the second half of 2026.

The structural case for AI remains intact, but index-level exposure concentrates risk in a narrow set of mega-cap names.

Hang Seng Tech's underperformance reflects sector mix, earnings pressure, and a shift in the AI narrative.

While political developments will shape the policy environment, their impact on markets is likely to be secondary to the broader economic cycle and earnings outlook.

Most central banks have since adopted a wait-and-see approach as the Middle East conflict’s macroeconomic impact gradually becomes clearer.

Alternative assets offer characteristics that can replicate or complement public market exposures, benefiting portfolios through low mark-to-market volatility and reduced correlation to public assets.

Geopolitics is acting less like background noise and more like a direct style driver.

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<p>Mid-Year Outlook 2026</p>

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