Year to date, equity markets have delivered impressive returns despite an environment that has often appeared challenging.
Trade tensions, geopolitical instability, elevated government borrowing, persistent concerns about inflation and fears over the sustainability of the US-led Artificial Intelligence capital expenditure cycle have generated periodic bouts of uncertainty. Yet developed market equities have continued to move higher, supported by resilient economic growth, robust corporate earnings and growing confidence that monetary policy will become gradually less restrictive over time, even if the path remains uneven.
Perhaps the defining feature of the current environment is the continued resilience of the global economy. For much of the past three years, investors expected the sharp rise in interest rates in the immediate aftermath of the pandemic to push developed economies into recession, but economic growth and corporate earnings have proved far more resilient than many anticipated. The United States remains at the centre of this resilience, supported by strong private sector finances, continued fiscal support and a powerful wave of investment in AI infrastructure, data centres and industrial reshoring. This spending has become an increasingly important source of economic momentum and corporate earnings growth. Elsewhere, policy support in China, rising defence and infrastructure spending in Europe, and broader efforts to strengthen strategic industries are also providing support to global activity, albeit on a more modest scale.
The next meaningful move in UK interest rates is more likely to be down than up.
At the same time, the investment landscape is evolving. The environment that characterised much of the decade following the Global Financial Crisis, marked by low inflation, exceptionally low interest rates and abundant liquidity, appears to be giving way to a more complex backdrop. Investors increasingly face a world shaped by technological transformation, geopolitical fragmentation and greater inflation volatility. While inflation has fallen substantially from its post-pandemic highs, it may prove less predictable than during the era of globalisation as governments place greater emphasis on economic resilience, supply-chain security, strategic industries and domestic investment alongside efficiency.
Fixed income has become considerably more attractive than it has been for many years. Higher starting yields provide investors with a meaningful source of income, improve prospective long-term returns and restore some of the diversification benefits that were largely absent during the era of ultra-low interest rates. We continue to favour shorter-dated government bonds, where yields remain attractive relative to cash without requiring investors to assume significant duration risk. Longer-dated bonds present a more nuanced picture. While they could perform well in a weaker growth environment, rising government debt levels, persistent fiscal deficits and increased borrowing requirements may place upward pressure on term premia over time, leaving long-duration bonds vulnerable to periods of volatility even as central banks gradually reduce policy rates.
Assessing the monetary policy outlook remains one of the key challenges facing investors. Financial markets have become increasingly sensitive to signs that inflation may prove more persistent than anticipated, leading to concerns that central banks could be forced to tighten policy further. Our central view is somewhat different. In the UK, we believe the Bank of England is likely to look through temporary rises in inflation driven by energy prices and other supply-side factors, focusing instead on weaker economic momentum, a softening labour market and evidence that private sector wage growth continues to moderate. Together, these trends suggest underlying inflation pressures are gradually moderating, increasing the likelihood that inflation will decrease more decisively in 2027 once the temporary impact of this year’s energy price increases drops out of the data. Whilst interest rates may remain elevated for longer than many expected a year ago, we believe the next meaningful move in UK interest rates is more likely to be down than up, with scope for further easing during 2027.
Financial markets have become increasingly sensitive to signs that inflation may prove more persistent.
In the United States, sticky inflation could yet delay further policy easing and keep monetary conditions restrictive for longer. However, we believe the more likely medium-term outcome is that moderating growth and easing inflation pressures ultimately allow the Federal Reserve to resume its interest rate easing cycle. While the path is unlikely to be smooth, we continue to believe the broad direction of policy rates will be lower over time.
One of the most encouraging developments over recent months has been the gradual broadening of equity market leadership. Earlier stages of the current bull market were heavily concentrated in a small number of large technology companies, many of which continue to benefit from strong earnings growth and significant competitive advantages. More recently, however, a wider range of sectors has begun to participate in the advance. Financials, industrials, defence companies, power infrastructure providers and selected commodity-related businesses are contributing more meaningfully to returns, reflecting themes such as AI investment, industrial reshoring and increased defence spending. International markets have also shown greater participation, although the United States remains the primary engine of global earnings growth and equity market performance.
Artificial intelligence remains one of the most important investment themes of our generation, but the investment case is entering a new phase. Initially, investors focused on the companies designing advanced semiconductors and building the infrastructure needed to support AI systems. Increasingly, attention is beginning to shift towards the businesses that can use these technologies to enhance productivity, reduce costs and improve profitability. As with previous technological revolutions, the ultimate benefits are likely to be distributed much more broadly across the economy than current market leadership implies. Financial services, healthcare, software, manufacturing and professional services all have the potential to benefit meaningfully as AI adoption accelerates, creating opportunities that extend well beyond today's infrastructure providers and technology leaders.
Against this backdrop we remain constructive, although not complacent. Earnings growth remains supportive, economic activity continues to expand and policy settings, while still restrictive by historical standards, are unlikely to become significantly tighter.
There has been a gradual broadening of equity market leadership.
Inflation remains an important risk, but central banks may be willing to tolerate some short-term volatility in price pressures if they believe underlying disinflation trends remain intact. While some areas of the equity market appear fully valued, opportunities remain attractive across a broader range of sectors, themes and geographies than has been the case for some time. Importantly, a more complex world does not necessarily imply lower returns. Rather, it reinforces the importance of diversification, active asset allocation and disciplined security selection — and the foundations for further progress remain intact. For long-term investors willing to look through short-term noise, the current environment continues to offer compelling reasons for optimism.
