The Federal Reserve’s first rate cut of 2025 was triggered by economic necessity. Yet, while the Fed has shown increased concern about deteriorating US employment, we see more economic upside than downside. AI capital expenditure continues to surge, China and emerging markets are delivering significant market returns and Europe has yet to show its true potential this cycle. We believe it is a time to remain invested, while acknowledging short-term risks and medium-term opportunities.
Still invested, selectively neutral
Market performance has been strong this year, with every equity and credit index posting gains. This reflects a combination of three factors:
|
1.
|
First, the impact from tariffs has been much lower than expected, in terms of growth and inflation for the US and the rest of the world
|
|
2.
|
Second, corporate balance sheets remain solid, suggesting the structural shape of the world economy outside of public debt appears robust
|
|
3.
|
Third, with the prospect of further rate cuts from the Fed, markets have more room to progress, especially when it comes to small- and mid-cap values, which are particularly sensitive to funding conditions.
|
These three elements support the case to stay invested. The overall economic backdrop is benign, opening the door to further progress for markets.
Bond rally set to continue
Concerns about fiscal deficits and potential inflationary pressures have created volatility across fixed income markets, particularly at the long end (see Figure 1). However, yields have recently dropped even with no signs of any resolution to these fiscal challenges – a shift that can be attributed to anticipated central bank policy adjustments. Market expectations of six Fed rate cuts within the next 12 months have exerted downward pressure on long-term yields, and we see this trajectory continuing despite lingering uncertainties relating to inflation.
Our medium-term outlook suggests US rates will probably decline toward the 3.75%-3% range – duration exposure should therefore continue to provide a positive performance contribution for fixed income portfolios.
FIG 1. 10-year yields vs term premium1
US equities, but not exclusively
The ongoing valuation premium in equity markets again raises the question of whether allocators should continue to reduce US exposure in favour of alternative regions such as China, emerging markets, the eurozone or Switzerland. At present, substantial US and Chinese capital expenditure in artificial intelligence and technology serves as a catalyst for future earnings growth, and the relatively expensive US equity segment is still attractive from a fundamental perspective. However, Chinese equities are trading at more modest multiples compared to their US counterparts – Alibaba's price-to-earnings ratio at 20x appears more favourable than Amazon's 40x multiple, for example2.
Currency dynamics have also significantly influenced equity performance this year. The US dollar's depreciation has altered the investment landscape, necessitating the incorporation of currency considerations into equity allocation decisions. Figure 2 illustrates that US productivity appears poised to contribute less significantly to economic expansion, while productivity momentum remains intact in China and is beginning to materialise in Europe. These elements present a compelling case for pursuing diversification beyond US markets while maintaining substantive exposure to US equities.
FIG 2. Estimated contribution of productivity to growth3
Our positioning across asset classes
Right now, our investment teams do not see a case for bearishness: the investment environment remains benign, with inflation outside of the US notably lower, the global economy still resilient and a few more interest rate cuts expected from G10 central banks. The valuation argument is a source of concern, but it primarily applies to US stocks, with the perspective that any market pullback could be used as a re-entry point.
Multi asset. The All Roads team remains neutral, with market exposure being maintained around 135%, with its allocation to protection and cyclical assets shifting slightly to 56% and 44%, respectively (rebased to 100%)4.
Fixed income. Our Global Fixed Income team remains neutral on sovereigns, holding a preference for Treasury Inflation-Protected Securities (TIPS) over nominal US Treasuries, but has moved to overweight emerging market (EM) hard currency debt. Within credit, exposure to investment grade and high yield (HY) i.e., neutral, with a defensive and selective tilt. Our Asia Fixed Income team is overweight China and Hong Kong, and equal weight India, with a focus on information technology (IT) and consumer discretionary.
Convertible bonds. The team is positive on the US and neutral on Europe and China. They have a positive outlook for equities globally, but favour key themes such as the entire US and Asian AI value chain, European defence and industrials, and US and Asian exposure to onshoring and other strategic activities.
Equities. Our Global Equities team has taken profits in Europe and rotated into China tech/internet. In terms of sectors, they remain overweight technology, media and telecoms, and consumer discretionary, and underweight healthcare and consumer staples. Our Swiss Equities team has de-risked by taking profits from well-performing stocks, and is overweight communication services, IT, healthcare and industrials. The Asia Equities team remains overweight China and Hong Kong, and is equal weight India.
