What’s the story?

As we approach the end of the year, volatility may persist across financial markets globally due to US election uncertainty, Middle East tensions, and general growth concerns. However, the investment environment remains attractive, as rate cuts are looming and investor sentiment is not excessively optimistic.

Moreover, our Research team considers potential temporary market corrections as more technical in nature than fundamental. In macroeconomic terms, we expect a bumpy and modest continuation of the cyclical recovery that is facilitated by resilient US demand, a continuation of the artificial intelligence investment cycle, Chinese manufacturing exports, and an overall robust demand for services that offsets manufacturing weaknesses. Central banks have also been increasingly shifting their focus from combating inflation to supporting growth, thereby paving the way for (further) interest rate cuts, with the US expected to join later this month.

Equities: Stick with the winners, potentially add to cyclicals

The spike in volatility in early August took some exuberance out of the market, laying the foundation for further advances. While we consider it quite possible that stock markets are not out of the woods yet and that a retest of the market lows could occur in the run-up to the US elections, this could present an attractive entry point for investors who are not yet fully invested in the current equity bull market.

In fact, the fundamental picture is likely still in favour of equities. Earnings growth has been broadening, and US equities have historically risen after interest rate cuts, provided they were not followed by a recession. This is our baseline scenario. 

Past evidence suggests that this means investors can focus on the winners (i.e. quality growth stocks) while diversifying into cyclicals, where our emphasis is on quality mid-caps, German stocks, industrials, and our Next Generation themes, such as Automation & Robotics and Future Cities. Additionally, artificial intelligence stocks are still a good way to participate in the fourth industrial revolution.

With regard to specific markets, we remain bullish on Japan, driven by expectations of further Japanese yen weakness, which is a traditionally good indicator of positive returns. In emerging markets, US election uncertainty and (local) election jitters limit the upside despite solid corporate fundamentals. This leads us to favour non-US-driven emerging markets, i.e. India, due to its structural growth, and – tactically – China, where the negative sentiment seems to be more than priced in.

Fixed income: Credit for yield, duration for hedging

Currently, we prefer USD (but also EUR) low-investment-grade bonds for those seeking yield and quality. In Europe, lower growth and inflation create a relatively friendly environment for high-quality bonds, and we still prefer peripheral over core sovereign bonds.

Following the decline in 10-year US Treasury yields to below 4.0%, we view longer-duration USD high-quality bonds as attractive from a diversification and hedging perspective given decent US growth. At levels around 5.0%, they might also appear attractive from a capital gains perspective. Overall, this shows that bond investors need to be more agile and move away from traditional buy-and-hold strategies. 

For investors who seek higher yields and are able to bear the risks, emerging market hard-currency debt remains our preferred fixed income segment. However, caution is warranted given the economic and political backdrop.

Gold and the US dollar: No love-hate relationship for now

Gold prices remained resilient over the summer, even breaking above USD 2,500 an ounce for the first time ever. The fact that the previous drivers of the record run (Chinese investment demand and central-bank buying) have paused makes this new record all the more remarkable. Yet the return of Chinese investors and central banks, whose main motivation, in many cases, is political rather than economic, will potentially fuel the next run. Since we expect the US dollar to remain rather rangebound, given that lower interest rates should be balanced out by the US economy’s superior growth, it could be beneficial for non-USD investors to invest in gold as well.

Alternatives: A good environment 

Within private equity, now may be a good time to add core asset-class exposure via building blocks that favour buyouts. Diversified private equity and co-investment funds featuring the middle-market buyout sector tend to offer resilience in the current environment. The companies in these portfolios often profit from exit opportunities via mergers and acquisitions, as well as lower leverage.

Hedge funds also tap into return drivers that are hardly, or not at all, available to traditional investors. Should we encounter a more volatile market environment in the coming months, as is broadly expected, hedge funds may be worthwhile considering, within a portfolio context, thanks to their potential ability to generate returns independent of market movements.

Wrapping up: What does this mean for investors?

Investors may well remain invested and enjoy the ride, as the autumn season promises to be eventful. By navigating the shifting investment landscape and adapting to new developments, investors can capitalise on the opportunities presented in this dynamic market environment. Now is a good time to lay the foundation for long-term investment success.