Investment Viewpoint: Why we remain constructive on markets

Simplify the complex with clear and concise market insights direct from our investment experts every week.

Markets and macro insights with Bernard Swords, Chief Investment Officer

Key takeaways:

1. Investor sentiment was driven by two key themes last week: rising tensions in the Middle East and growing questions about the return on the substantial investment being made in artificial intelligence (AI).
2. Global equity markets fell by almost 2% in euro terms, with technology stocks among the weakest performers as investors reassessed AI spending and profitability.
3. US inflation data continued to point towards easing price pressures, while consumer spending remained resilient.
4. Despite recent volatility, we remain constructive on the outlook, supporting by continued global economic growth and strong corporate earnings.
5. We have increased exposure to long-term structural growth themes, including energy security, through selected industrial, utility and technology companies.

Financial markets experienced a more challenging week. Why was this?

• Last week, investor sentiment was affected by two key themes: rising tensions in the Middle East and growing questions about the return on the substantial investment being made in AI.
• Global equity markets declined by nearly 2% in euro terms over the week. Technology stocks were among the weakest performers as investors reassessed the pace of spending on AI-related infrastructure and whether those investments can ultimately generate sufficient profits.
• Results from major companies in the sector, including Taiwan Semiconductor Manufacturing Company (TSMC) and Dutch semiconductor equipment manufacturer ASML, confirmed that spending on AI infrastructure remains exceptionally strong.
• However, as investment levels continue to rise, investors are increasingly focused on when these expenditures will begin to translate into meaningful earnings growth. While concerns around AI profitability tend to ebb and flow, competition among companies to establish strong positions in this rapidly evolving area is likely to ensure that investment remains elevated for some time.
• As a result of the more cautious market environment, investors favoured defensive sectors such as healthcare, consumer staples and utilities, which were among the strongest performers during the week. Financial stocks also performed well, particularly in the US where several leading banks reported strong quarterly results at the start of the earnings season.
• Meanwhile, ongoing tensions in the Middle East continued to put upward pressure on energy prices. Brent crude oil moved higher during the week as investors monitored developments in the region and the potential implications for global energy supplies. Higher oil prices contributed to renewed pressure on bond markets, with government bond yields rising modestly.

What were the key economic data developments last week?

• Economic data released last week was generally supportive of the view that inflationary pressures continue to ease gradually in the US.
• US consumer price inflation showed further signs of moderation, with core inflation falling on a monthly basis and annual core inflation declining to 2.6%. Producer price inflation also came in below expectations. This suggests that the disinflationary trend remains intact, partly reflecting the fading impact of tariff-related price increases seen last year. If this trend continues, inflation should gradually move lower over the coming months.
• At the same time, growth indicators remained encouraging. US retail sales data highlighted the continued strength of consumer spending. While monthly growth was broadly in line with expectations, earlier months were revised upwards, leaving retail sales growth running at more than 6% year-on-year. This points to a consumer sector that remains healthy and continues to support economic expansion.
• In contrast, economic data from China was disappointing. Economic growth came in below expectations, with weaker investment and subdued consumer spending weighing on activity. Capital investment has continued to decline, while retail sales growth remains modest. The technology sector, particularly exports linked to AI-related equipment, remains one of the few areas providing meaningful support to the Chinese economy. Policy measures from Chinese authorities also continue to fall short of investor expectations, with the emphasis remaining on speeding up the implementation of existing measures rather than introducing significant new stimulus.
• Within the euro area, industrial production data was slightly weaker than expected, highlighting the more subdued growth environment across Europe.

Why do we remain constructive on markets?

• Despite recent volatility and ongoing geopolitical risks, we remain constructive on the outlook for financial markets. The global economy continues to grow, corporate earnings are strengthening, and we believe that current portfolio positioning remains well aligned with the opportunities and risks facing investors during the second half of the year.
• The Wealth Management Asset Allocation Committee met last week to review market conditions and portfolio positioning. Market movements over recent months have resulted in our portfolios moving into an overweight position in equities. Following detailed discussion, the committee agreed that this remains appropriate given the underlying economic and corporate backdrop.
• The global economy continues to demonstrate a high degree of resilience. Growth is expected to remain around long-term trend levels over the next several years, supporting a favourable environment for risk assets. Furthermore, economic activity has proven more durable than many expected earlier in the year, suggesting that the current cycle may have further to run.
• Corporate earnings remain particularly encouraging. Rather than the earnings downgrades that often emerge as a year progresses, companies across a broad range of sectors have delivered meaningful upgrades to profit expectations. Importantly, this strength is not confined to technology and AI-related businesses but is evident across many areas of the market.
• Within fixed income markets, the repricing of central bank interest rate expectations has created some challenges. However, we believe that much of the adjustment to higher-for-longer interest rates has now been reflected in bond valuations. Given continuing uncertainty around interest rate expectations, we continue to favour shorter-duration exposure. We also maintain a preference for high-quality corporate bonds over government bonds, supported by strong company balance sheets and attractive relative valuations.

How are we positioning portfolios in the current environment?

• During the month we made some adjustments to our equity portfolios, increasing exposure to areas that we believe are well positioned to benefit from longer-term structural trends.
• In particular, we added exposure to themes linked to energy security, through selected industrial, utility and technology companies. The prolonged uncertainty surrounding the Middle East and concerns about the security of global energy supplies have reinforced the importance of energy independence and diversification. We believe these developments will encourage increased investment in alternative energy sources, energy infrastructure and broader energy security initiatives over the coming years.

The week ahead: what to watch out for

This week is expected to be relatively quiet from an economic data perspective, with the main focus on business activity surveys, including the Purchasing Managers’ Index (PMI) reports from both the US and the euro area.

Investor attention is therefore likely to remain centred on geopolitical developments and the ongoing corporate earnings season. Company results will be particularly important in determining whether strong earnings growth can continue to support equity markets and whether concerns regarding the profitability of AI-related investment begin to ease.