Investment Viewpoint: a period of adjustment as market conditions stabilise

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Markets and macro insights with Bernard Swords, Chief Investment Officer

Key takeaways:

1. The Global equities eased by almost 1.5% in euro terms over the past week, with weakness concentrated in growth-oriented sectors including technology, communication services and parts of consumer discretionary.
2. Fixed income markets had a more constructive week, particularly in the euro area, where government bond yields declined modestly as energy markets showed further signs of stabilisation.
3. The broader picture remains one of adjustment rather than deterioration. Equity markets are consolidating after strong gains earlier in the year, while easing energy prices are supporting the inflation outlook, particularly in Europe.

Equity markets have declined slightly. What was the cause?

• Global equities experienced a modest pullback over the past week, declining by 1.4% in euro terms.
• The weakness was concentrated in the more growth-oriented ‘new economy’ sectors, particularly technology, communication services and parts of consumer discretionary. Two developments appeared to weigh on sentiment.
• Firstly, there were reports suggesting that OpenAI may delay its planned IPO until next year due to recent volatility in the sector, which unsettled investor confidence.
• Secondly, Apple announced price increases on some of its products due to rising input costs, raising questions about profitability across the broader technology sector.
• While this created some concern, it is worth noting that the ability of companies to raise prices in the current environment is relatively rare and points to a degree of resilience.
• This period of uncertainty in growth sectors supported more defensive areas of the market. Healthcare was a standout performer, rising by over 7% during the week, while other defensive sectors such as consumer staples, utilities and property also delivered positive returns.
• Following a very strong run in technology and related sectors in recent months, some consolidation was to be expected, and the recent pullback appears consistent with a normal pause rather than a fundamental shift in trend.

How did fixed income markets perform?

• Fixed income markets had a more constructive week, particularly in the euro area. Government bond yields declined modestly, with the yield on the 10-year German government bond now only around 20 basis points above where it stood before the recent escalation in Middle East tensions, and still significantly below its recent peak.
• This reflects a broader stabilisation in market conditions, especially in energy markets. Brent crude oil is now only around $3 per barrel above its level at the start of the conflict. While the conflict has lasted longer than initially expected, the impact on energy prices has been more contained than feared.
• Shipping activity through the Strait of Hormuz remains reduced, estimated at around half of pre-conflict levels. However, markets appear to have adjusted quickly to this disruption.
• Lower energy prices are particularly supportive for the euro area, which is a net importer of energy. They also help improve the outlook for inflation. As a result, investors increasingly believe the European Central Bank may not need to raise interest rates further in the near term.
• The earlier sell-off in euro area bonds, which pushed yields higher, has now largely reversed. This suggests fixed income markets are finding a more stable footing.

Why does the US outlook remain less clear?

• The outlook in the United States remains less settled. US bond markets continue to adjust to changing expectations around monetary policy.
• Earlier this year, investors were not expecting any further interest rate increases from the Federal Reserve. That view has now shifted, with markets pricing in the possibility of two further rate increases by year-end and potentially more over the following twelve months.
• Recent US economic data has not provided a clear direction. The Federal Reserve’s preferred inflation measure, the Personal Consumption Expenditures (PCE) index, indicates that inflationary pressures remain persistent. Core inflation is still running well above 3% on an annual basis and is expected to decline only gradually. This suggests interest rates may need to remain higher for longer to bring inflation back under control.
• In the euro area, the latest business sentiment surveys showed some tentative sign of improvement. Purchasing Managers’ Indices (PMIs) pointed to a modest improvement, particularly in services, which had previously been an area of weakness.
• The composite index remains just below the 50 level, indicating a slight contraction in economic activity. However, it is close to stabilisation, suggesting the economy is broadly flat rather than slowing sharply. Manufacturing activity continues to hold up relatively well and remains in expansionary territory.

What is the overall outlook?

• Overall, while markets experienced some volatility last week, the underlying picture remains one of gradual adjustment rather than deterioration.
• Equity markets are absorbing the strong gains seen earlier in the year. Bond markets are stabilising. Easing energy prices are also helping to support the inflation outlook, particularly in Europe.
• For investors, the key message is that recent market moves appear more consistent with normal consolidation than a change in the broader outlook.

The week ahead: what to watch out for

The economic calendar becomes busier in the week ahead. In the United States, the key release will be the non-farm payrolls report, which will provide an important update on the strength of the labour market. Investors will be watching closely to assess whether recent employment resilience is sustainable or has been supported by temporary factors.
The ISM manufacturing index will also be closely watched for further evidence on whether the recovery in US manufacturing is continuing.
In Europe, attention will turn to the latest inflation data, which will be an important input for European Central Bank policymakers. Consumer confidence figures from both the euro area and the US will also be released, offering further insight into how households are responding to the current economic environment.