Multi-Asset Investments Views: And I can’t breathe without you, but I have to

As we flagged in our previous Multi-Asset Investment Views, whilst macroeconomic fundamentals remain strong, the optimistic to even slightly-stretched investor sentiment and positioning may require this 21-month bull market to take a breather and consolidate.

The historically extreme reliance on a very few big tech names was also cause for concern. As the expected earnings growth of the US tech sector is expected to decelerate in line with the broad market into year-end (see chart below), the extreme dominance of a couple of companies raises the question of sustainability of the current rally if their fortune changes. The recent market moves have only reinforced our conviction and we therefore maintain our neutral risk appetite.

The first half of this year saw impressive equity returns¹  – the MSCI AC World Index gained 14.7% in euro terms²  –  but this was almost entirely driven by the artificial intelligence (AI) theme and the huge outperformance of the so-called ‘Magnificent Seven’ in the US. The rest of the market basically went nowhere fast and now leaves us considering a backdrop of stretched positioning and themes, whether that be large cap versus small, growth style versus value, momentum versus almost all other factors and of course technology versus the rest of the market. Whilst timing is near impossible to call, these exaggerated moves nevertheless leave markets at the mercy of unusual bouts of internal volatility, which can be seen in episodes of sharp sectorial and style rotations.

The 10% jump in the US Small Cap index (Russell 2000) in reaction to the softer US CPI inflation data is the most recent case in point. Whilst we have no reason to doubt the AI story over the medium term, the market will be increasingly focused as to how companies can monetise their investments. The broad benefits could take a considerable time to be realised. 

The market has also quickly moved to fully price two US Federal Reserve (Fed) interest rate cuts before year-end and several more in 2025. Yet the yield curve has begun to re-steepen and reflect expectations of Donald Trump winning the Presidency and a Republican clean sweep of the Senate and the House. The Fed will struggle to reduce rates if the incoming administration is playing fast and loose with fiscal policy and enacting unfunded tax cuts. Lest we forget, there are still four months to go before the US Presidential Election and there are likely to be more surprises from both candidates and their parties. 

Recent events have bolstered the Trump campaign, so investors integrate a higher probability of the policy consequences of an administration identified as protectionist (with tariffs and border control rising), fiscally regressive (with unfunded tax cuts for the wealthiest) and loosening regulations (on banks, fossil fuel industries and tech). On balance, the US is likely to get an inflationary boost into 2025. Volatility is currently looking cheap across the asset class spectrum and, whilst insurance always has a cost, it’s better bought cheap than once you need it.

Europe is once again in a tricky position. The political ructions in France are not welcome from a market perspective which may see a political risk premium attached to the Eurozone. Flows from international investors into the region have not been as strong so far this year versus 2023. Equity markets have derated, whilst second-quarter earnings have brought their fair share of warnings. Besides, there is still little sign of the long-awaited manufacturing recovery to unlock some cyclical performance and recent misses on China’s growth numbers have added to the negativity. We think the UK looks relatively attractive, as political stability has improved there, but the strength of sterling is proving a headwind for now.

On the fixed income side, we remain defensive. We recently reduced duration and prefer the short end of yield curves to invest new cash. Whilst the Fed is expected to reduce rates before year-end, and the European Central Bank to continue lowering rates after its June cut, there is some caution required that the pace of cuts going forward may once again disappoint investors. Whilst not ‘fighting the Fed’ as such, they are certainly calling its bluff.

All in all, performance, investor positioning and recent news flow leave us comfortable with remaining at the long-term, neutral levels of active risk for the next few weeks, along with smaller but specific positions in fixed income and currency markets.