The resilience story continues

Inflation continues to face pressure from high energy prices and is expected to stay above the central bank target of 2% in both the US and Europe. Therefore, we expect an additional rate hike from both the European Central Bank (ECB) and the Federal Reserve (Fed) this year.

Long-term bond yields have also risen significantly, which increases borrowing costs throughout the economy. On top of that, geopolitical tensions remain high, which also leads to supply shocks. Despite these headwinds, global growth has repeatedly proven resilient, with recent economic forecasts more often upgraded than downgraded.

The large investment waves in AI, defence and the energy transition continue to provide sufficient tailwinds to outweigh the headwinds. As a result, we continue to expect economic growth in all major regions next year.

Bond yields have risen sharply around the world over the past few months. That said, there are glaring differences between countries. Within Europe, developments in the French bond market are especially worrisome for investors. The country is dealing with a toxic cocktail of high government debt, budget deficits and political unrest that spooks bond investors. This is causing the spread between French and German government bond yields to widen considerably. We continue to be cautious about French debt.

The rise in bond yields has mostly been driven by a rise in real rates, rather than a rise in the term premium or rising fiscal risks. Therefore, bonds as an asset class have become more attractive recently. However, we remain patient as bond markets continue to adjust to higher yield levels.

Since we adopted a positive view on the IT sector in August, the sector has performed well and more of the anticipated earnings upside from AI is now reflected in share prices. This rally has been driven by a strong long-term outlook for IT, AI adoption, cloud spending, digital transformation and improving earnings trends.

This strong performance has reduced further upside potential. Future returns are now more dependent on earnings delivery and further valuation expansion. In addition, the earnings season and US midterms could lead to more market volatility. Therefore, we are taking some profits by reducing our IT position back to neutral.

Outside the IT sector, a large part of the market has been struggling in recent months, with many US stocks trading below 10% or even 20% from their previous highs. Although this underlines the high concentration and low breadth in the market, we believe that these lagging parts of the market could recover.

Combined with the relatively strong economic and earnings growth in the US, this strengthens our conviction for the region. Europe, on the other hand, is still more exposed to the high energy prices and political uncertainty. Therefore, we raise our position in US equities from overweight to a strong overweight position and reduce European equities from underweight to strong underweight. Additionally, we maintain an overweight position in emerging markets. Finally, we maintain a positive view on equities as a whole.

Despite above target inflation and rising yields, large investment waves provide sufficient support for economic growth in all major regions. Higher yields have improved the appeal of bonds, but we remain patient while bond markets adjust to the higher yield environment and stay neutral for now. We remain positive on equities, but within equities we take some profit on the IT sector, while increasing our preference for US compared to European equities. At the same time, we maintain an overweight position in emerging markets. Finally, gold continues to provide portfolio diversification while benefiting from long-term tailwinds.

Richard de Groot
Chair Global Investment Committee