That said, we think allocators should consider diversifying exposure from growth-dominated US equities to more value-oriented non-US equities. We continue to favor Japan, with its improving earnings outlook and shareholder-friendly policies, while we have a moderately underweight view on Europe. Optimism about German fiscal support is understandable, but we’re not seeing it come through in broad earnings revisions or market breadth, and France and the UK are facing budget tensions. Within EM, we see a stronger case for taking risk in debt than equities. EM equity outperformance vs. DMs has been driven by multiples, not earnings, and China, the largest index weight, has benefited from positive sentiment around AI and retail flows while the economic fundamentals have deteriorated.

In fixed income, we continue to see opportunities to take advantage of regional differences in monetary policy and market pricing. Our highest-conviction view is to be long UK rates. Term premia⁴ are compensating for fiscal concerns in our view, and we expect a weaker economy to spur further rate cuts by the Bank of England. This contrasts with Europe and the US, where rate cuts may fall short of market expectations. In credit, we lowered our view on high yield to neutral when spreads⁵ approached their all-time tights, and we raised our view on EM debt to moderately overweight. Around half of EM debt is IG, and spreads aren’t as compressed. We’re monitoring credit closely after pockets of weakness surfaced in consumer finance in the US, particularly among lower-income cohorts, though these appear to be isolated cases rather than signs of broader economic or credit risk.

Equities: Still a Positive Vibe, Though Valuations Give Pause

We continue to hold a moderately overweight view on global equities. While the post-April rally has been strong and US equities are expensive, the global earnings picture is solid—though admittedly driven by US mega caps—and the policy backdrop is supportive, as central banks are easing globally, apart from Japan (FIGURE 2). While questions remain regarding US tariffs (e.g., a Supreme Court ruling on their legality), much of the uncertainty is behind us, and companies have mitigated some of the impact by passing on roughly half the cost to consumers or down the supply chain.

We continue to view AI positively, with the massive investments being made providing a near-term boost to the economy and potentially driving even more meaningful long-term productivity gains. Despite the investments required, the largest tech companies have been able to generate strong cash flows and maintain high margins.

Why aren’t we more positive given these drivers? Valuations have risen, particularly in non-US markets with weaker earnings growth, and uncertainty remains high on several policy fronts in the US and elsewhere, including around issues of fiscal sustainability, monetary policy independence, and regulatory and industrial policies.

As we noted last quarter, central banks are generally moving toward rate cuts, but the magnitude, timing, and market expectations vary substantially, and so we see opportunities to take advantage of these regional differences within our long-duration view. Our highest-conviction regional view is to be long duration in the UK, which has been the poster child for poor fiscal management since 2022, when former Prime Minister Liz Truss signed off on tax cuts combined with big borrowing, and markets revolted. Today, the term premium is higher than during the “Truss moment.” With the UK facing a fiscal shortfall and new rules requiring a balanced budget by 2029–2030, all eyes will be on the budget announcement in late November. The consensus is that Chancellor Rachel Reeves will present a combination of tax hikes and spending cuts equivalent to £30 billion or 0.35% of GDP a year, but we think the fiscal hole will be substantially smaller and spread out over several years through 2028. 

In contrast to our bullish UK view, we’re bearish on the US, Europe, and Japan. We think the market’s gotten ahead of itself on Fed rate cuts in the US because inflation is still sticky and recession risks are low. There’s not much more cutting for the European Central Bank to do, after already delivering 150 basis points⁹ of rate cuts over the past year, and we see some upside growth potential from German fiscal expansion. We maintain our short-duration view on Japan, where monetary policy is accommodative, inflation risks are to the upside, and fiscal policy is likely to loosen following the election.

Credit: Time To Take Profits in High Yield?

Tight spreads keep getting tighter, so upside is limited. We’re seeing isolated cases of credit stress in consumer finance emanating from weaker income cohorts such as subprime and 24–30-year-olds struggling with higher unemployment and the resumption of student-loan repayments. Still, we see no clear catalyst for broader spread widening, and the overall backdrop appears positive for risk assets,¹⁰ with liability-driven allocators looking for attractive all-in yields in the 4%–6% range. Given rich valuations, however, we believe the time has come to move up in quality within credit, from high yield to EM sovereign debt.

The macro backdrop for EM is positive—Fed easing, a weaker USD, and loose financial conditions. EM debt’s composition is about 50% IG and 50% high yield, a more defensive allocation relative to equities than high yield. In addition, US high-yield bonds are callable, giving this market a negatively convex profile¹¹ relative to the bullet structure¹² of EM debt and IG corporate bonds. Finally, EM debt offers a potential spread pickup relative to both global corporate IG bonds and high yield. In a more stressed US economic environment, EM debt spreads would also tend to benefit from their longer duration relative to other spread markets.

Commodities: Focusing on Oil and Gold Prices

We have a moderately underweight view on commodities driven by our view on oil, where we have a small underweight view given the rise in oil prices. With OPEC barrels returning, the demand/supply balance points to a potentially sizable oversupply. We think this makes for an attractive entry point for shorting crude, with the primary risk being the substantial negative carry¹³ drag.

We’ve taken off our long-standing overweight view on gold. While the geopolitical environment and the investor/central bank urge to diversify remain favorable for gold, recent momentum has taken the gold price beyond our target, and the technical set-up looks somewhat fragile after the strong push higher.