What matters most in uncertain markets

It has been quite an active week in markets and we wanted to put the moves into context. On balance, we were reassured by the market reaction. AI-related stocks weakened somewhat, but other parts of the equity market held up well. Government bond yields in the US moved lower, despite higher than expected inflation. Portfolio diversification proved effective in this environment.

Just to recap, over the past few weeks we’ve seen a couple of key drivers for markets. First, there’s the ongoing debate about Artificial Intelligence: will all the investment we’re seeing pay off? Second, there are the sharp increases in bond yields, which have put the spotlight on countries like France. 

These themes feed into a tug-of-war around growth and inflation. Continued AI spending is likely to support global growth and, through the demand for resources, potentially sustain higher inflation as well¹. In contrast, sustained higher rates will put pressure on some parts of the economy and potentially slow down growth. So far, AI spending has helped to prop up global growth, but we think some of the moves this week reflect investor concerns about potential risks to growth.

This week there’ve been some quite sharp moves in financial markets. AI was at the forefront, with Korean equities being particularly volatile. On the fixed income side, we’ve seen interest rates initially rise in response to higher than expected inflation data in the US, only to fall quite sharply thereafter. 

What should we think about this?

On the equity side, it’s worth noting that the moves down have been quite concentrated in the AI space. Over the past few days (through Thursday), among US and European sectors, only the tech sector and some US industrials have shown declines. Most sectors have moved higher. Obviously the tech sector has a large weighting in global indices, but the differentiation between sectors is notable. On the fixed income side, you might have expected bond yields to rise in the wake of higher than expected inflation in the US, but the move lower suggests that investors had collectively already anticipated the higher inflation print. 

In terms of portfolio positioning, diversification remains key, both between equities and fixed income and within equities. 

Fixed income yields have moved higher over the past few months and can provide attractive income for investors, even in shorter-dated bonds. We are paying close attention to the credit space, where the interest rates on high-yield corporate bonds have moved higher. High-yield bonds have been pretty resilient in recent months, and we think that reflects the solid economic growth we’ve seen, particularly in the US. If we see high-yield spreads continue to widen, that could be a sign investors are looking for weaker economic growth going forward. 

Within equities, the focus has been on AI and AI-adjacent sectors, but we’ve seen our UK and European positions hold up well. While we’re currently positive on the outlook for AI and tech spending more broadly, we continue to maintain a diversified equity exposure. 

Overall, we think global growth is so far holding up well, despite higher oil prices. Inflation is proving sticky, and central banks will likely raise rates over the coming months, with another rate hike in the US likely in December. But we think that starting bond yields are attractive, while earnings growth continues to hold up, based on the early reports from the third quarter results in the US. We’ll continue to focus on those company reports and their outlook over the coming weeks.

1. There’s much debate about whether AI will be deflationary in the long-term. For now, we think that during the current build-out of infrastructure, AI is more likely to be inflationary than deflationary. ↩︎