Allocation Views: Bubbles, Bifurcation and the Case for Staying Invested

Summary

Our “risk-on” thesis remains intact heading into September, supported by resilient growth and strong corporate fundamentals despite geopolitical tensions, inflation pressures and uncertainty around artificial intelligence.

We favour diversified equity exposure, retaining a technology tilt while mitigating potential AI-bubble risks.

Inflation and policy remain key market concerns, but robust US and emerging market corporate earnings continue to support our equity positioning.

Elsewhere, we retain a preference for international government bonds amid rising expectations for tighter monetary policy.

Macro Themes

Strong Growth

• Macro growth remains strong, supported by strong corporate earnings power.
• The US economy has proven especially resilient; most estimates of US growth are above-trend.
• Leading economic indicators look healthy, but we are monitoring the impact of higher input costs and softening payroll data.

Complicated Inflation

• US inflation dynamics continue to be challenged by a prolonged period of elevated core inflation, although recent data has been more positive.
• We expect limited second-order effects from the energy impulse, as supply driven inflation will reduce real incomes and suppress consumer spending.
• Core goods inflation has marginally improved. Tariff pressures have waned, but we are monitoring global supply chain tightness.

Tighter Monetary Policy

• Heightened tensions in the Middle East have catalyzed a recalibration of policy expectations, with a tightening bias in all major regions including the United States.
• A more hawkish FOMC approach is now priced into markets, as Fed Chair Warsh focuses on reinforcing credibility and independence.
• Fiscal policy is supporting growth but contributing to expanding deficits. Defense spending and energy support packages could also prove influential.

Portfolio Themes

Cross Asset: Risk-On

• Corporate fundamentals remain strong amid double-digit earnings growth expectations for the next 12 months.
• Macro growth remains constructive but is offset by a complicated inflation and policy backdrop.
• Sentiment and positioning have become more exuberant but are not yet at levels of concern. 

Equity Diversification

• Our equity exposure is tilted toward AI, reflected as overweight exposure to the US, EMs and Japan.
• European macro and corporate fundamental indicators have improved. Earnings-per-share (EPS) growth forecasts have strengthened amid rising corporate profitability.
• Australian equities remain our least preferred region due to a mixture of weak domestic growth, unsupportive fiscal policies, and tight monetary policy.

Neutral Duration

• We expect demand destruction to have a greater impact on monetary policy decisions than market pricing suggests, decreasing the chance that international central banks meet market hiking expectations.
• Resilient US growth and elevated inflation complicate Fed policy. We maintain a relative preference for international duration.
• Excess returns for equities appear more attractive than credit, amid strong earnings and tight spreads.  

Our “risk-on” thesis remains intact as we move into September. Robust growth and strong corporate fundamentals provide a solid foundation for our optimism, despite geopolitical tensions, inflation pressures and AI uncertainty.

We feel comfortable employing a diversified approach to equity investment, retaining a technology tilt while minimizing the impact of any potential AI bubble.