Coffee Break

Last week in a nutshell

• AI-related risk reduction broadened, as semiconductor weakness and wider credit spreads exposed growing concerns around the financing of the investment cycle.
• Middle East risks escalated sharply, pushing the price of Brent above $115/bbl and adding another shock to an already demanding backdrop.
• France became Europe’s clearest stress point, with OAT-Bund spreads widening sharply as political, fiscal and growth concerns reinforced one another.
• Core government bonds regained their defensive role, rallying as equity stress, French sovereign risk and geopolitics converged. Gold was notably less convincing.
• Earnings remained resilient but the hurdle rose, with guidance and visibility increasingly decisive as markets are entering a multi-week test.
   

Investment convictions

Core scenario

•  The next four weeks form a dense catalyst corridor, with central-bank decisions, mega-cap earnings, political votes, fiscal tests and geopolitical summits arriving in quick succession.
• Slight overweight Equities. We have upgraded US equities to a slight overweight, alongside maintained preferences for Japan and emerging markets.
• Macro conditions are robust. US investment and consumption sustain expansion, while Europe’s recovery remains more dependent on public spending. Lower energy prices would provide additional support.
• Ongoing Q3 earnings season. We have a constructive stance on Q3 results but acknowledge that guidance must now validate profit expectations despite higher financing costs.
• Limited additional tightening. Tightening financing conditions give the Fed scope to pause as underlying inflation becomes less concerning.

Risks

• Geopolitical fragmentation. Entrenched US–China rivalry and renewed trade friction could disrupt supply chains, investment and corporate margins.
• Persistent energy pressure. Prolonged disruption linked to Iran could keep energy costs elevated, squeeze demand and require more monetary tightening than expected.
• Fiscal credibility. Heavy issuance and political uncertainty could push yields and sovereign spreads higher, tightening financing conditions without stronger growth.
• Earnings disappointment. Elevated expectations and concentrated leadership leave equities vulnerable to weaker guidance, particularly among technology companies driving profit upgrades.

Cross asset strategy

• We are slight overweight on equities. We are slightly overweight US equities, alongside maintained preferences for Japan and emerging markets.
• Regional allocation:
  • Slight overweight United States. Resilient growth and strong earnings momentum into next year is supporting equity markets.
  • Slight overweight Japan. Supportive government initiatives and a relatively prudent BoJ provide a favourable backdrop for risky assets. Also, its world-leading franchises in robotics, factory automation and industrial equipment should position the market to benefit from the next phase of AI-driven productivity growth.
  • Neutral Europe. Sector composition appears less exposed to dominant market themes, but the region could benefit from easing energy prices if tensions in the Middle East decline.
  • Slight overweight Emerging markets. A selective approach within the region is warranted, but the overall strong exposure to Tech is a supportive though volatile factor. Valuation is attractive, revealing a significant discount to developed markets.
• Factor and sector allocation:
  • We favour themes that benefit from long-term investment cycles.
  • We remain constructive on the Healthcare sector and keep exposure to some industrial stocks benefitting from expansionary budgets.
• Government bonds:
  • We are long Core European Bonds duration. The Iran war has led to an inflation-driven repricing. Therefore, ECB central bank expectations have been cemented into rate hikes. We focus on high quality, core-European AAA-rated sovereign bonds, which still enjoy both fiscal and central bank credibility.
• Credit:
  • Despite recent widening, spreads in European Investment Grade remain insufficient to create a broad valuation opportunity while macro uncertainty remains elevated. Investment Grade fundamentals remain solid, but sensitivity to higher rates warrants a neutral positioning. For the moment, we favour maintaining selectivity rather than holding an overweight position.
  • Neutral on Investment Grade credit in both the US and Europe. High Yield technicals are deteriorating amid outflows and increasing supply, justifying the recent spread widening. Within High Yield we’re neutral on Europe and negative on the US.
  • We are positive on Emerging market debt via Sovereign Local Currency debt as the spread tightening trend is unfolding again and there is some leeway to see further compression ahead. In addition, current yields above 7% represent an attractive carry for this income-diversifier position.
• Alternatives:
  • We remain constructive on gold.
  • We hold precious and strategic metals, alternatives and market-neutral strategies for portfolio stability and diversification.
• Currencies:
  • The current market regime favours currencies linked to commodities. Therefore, we have long positions in AUD.
  • Election dynamics support the BRL, hence we are constructive on the currency.
  • We remain long JPY.

Our Positioning

Risk aversion returned as three pressures converged: renewed escalation in the Middle East, mounting concerns about the financing of the AI investment cycle and renewed stress in European sovereign markets. Brent rose to a five-month high, reviving concerns that a prolonged energy shock could reinforce inflation while weighing on growth. Our positioning remains mildly constructive as global activity remains robust, with a slight overweight in equities through the US, Emerging Markets and Japan. In fixed income, we acknowledge the sharp adjustment in global sovereign bonds, largely driven by higher real yields, increasing financing costs. Rising rates create a more demanding environment. We favour Emerging Market debt and are constructive on high quality, core European duration. Within credit, we prefer European Investment Grade over High Yield, where risk premia remain limited despite the recent repricing. We maintain a preference for the JPY as a hedge, which remains historically extremely undervalued, selected emerging-market currencies and keep commodity-linked currencies such as AUD. We also maintain a long position in the BRL, benefitting from Brazilian election dynamics. Finally, gold, strategic metals and alternative strategies continue to play an important diversification role in a world of supply constraints, policy divergence and real-rate volatility.