November Barometer of financial markets outlook

This does not bode well for equities. And neither does the fraught geopolitical backdrop. In the US, investors are bracing for a potentially more unpredictable Trump administration if, as seems likely, the opposition Democrats secure control of both the House and the Senate in congressional elections. The picture on the other side of the Atlantic is perhaps even more concerning. There, the French government has so far failed to convince investors that it can deliver a budget that would reduce public sector deficit from the current 5.4% while dealing with social unrest.

Valuations of stocks compared to bonds don’t look especially compelling either (see Fig. 2).

But the picture isn’t universally bleak. Economic growth remains healthy, with US and European GDP expanding at rates near to what we consider to their long-term potential. US corporate earnings should increase by some 15% next year even if, as we expect, profits among AI firms are less likely to outpace forecasts. Technical signals are also positive for stocks.

Taking all this into account, we have decided to downgrade equities but only to neutral – the risks of a correction in stocks are counterbalanced by some encouraging signs elsewhere. We leave our neutral stance on bonds unchanged as the clear value embedded in the asset class is unlikely to be unlocked in the absence of a wider growth shock.

Our business cycle indicators show generally healthy conditions across the developed world. US GDP growth is proving stronger than we had previously forecast. We now expect to see an expansion of about 2% both this year and next – in line with its long-term rate. Consumption and capital investment are likely to hold up well. Inflation meanwhile should peak by the first quarter of next year.

The European economy is also expected to be a bright spot. We see GDP growth rising to 1.4% next year from 1% this year, thanks to a pick up in defence spending and exports. 

By contrast, the Chinese economy has undershot our expectations. While exports remain strong, the country’s weak property market and lacklustre consumer spending continue to weigh on overall growth.

Beyond China, however, emerging markets have proved remarkably resilient to an oil price rise that in the past would have hit growth. Asian economies in particular are benefiting from AI-related investment.

Our liquidity indicators show a sustained deterioration in financial conditions that is negative for riskier asset classes. Borrowing costs in the US, Europe and Japan are on the rise and we don’t see any reason to expect a pick up in lending among commercial banks. China is the only major economy where financial conditions are easing and we expect the central bank to provide more stimulus.

Our valuations analysis shows that, while equities have cheapened following the recent pullback in stock markets, they remain expensive, not least when compared to bonds. Bonds appear more or less fairly valued in aggregate. In government debt, there is value to be found in inflation-linked bonds in the US and UK.

Technical signals are broadly supportive for stocks. Seasonal readings are positive – equities tend to do well in November as institutional investors maintain their allocations ahead of a year-end rebalancing. However, hedge funds have reduced exposure to risk in general, and especially to the AI ecosystem, to match previous lows in such cycles.

Despite recent turbulence, we remain overweight IT. AI-related earnings and investment remain strong despite greater scrutiny of financing and returns on capital.

Regionally, we still see strong potential in emerging markets ex-China. Emerging markets remain one of the strongest parts of the global economy. Higher commodity prices have been absorbed considerably better than in 2022, with stronger trade balances and much smaller currency depreciations limiting the tightening of financial conditions. Commodity exporters remain particularly well positioned, while Asian economies continue to benefit from the AI and global investment cycle. As a result, the profits outlook for emerging market companies is healthy: our model suggests earnings growth of 27% next year compared to 17% for global equities. Investment inflows into the asset class remain supportive, with investors keen to re-establish positions soon after any minor market fall. 

However, we take a more cautious stance on Chinese equities, downgrading them to underweight. China is now the only negatively-rated country in our macroeconomic model, with domestic consumption and investment remaining weak.

In developed markets, we hold neutral positions in both US and European stocks. Economic activity in both regions is running at around potential. However, both also face fiscal and political risks, which deter us from increasing our allocations. 

We also retain an overweight in gold. Although its valuations remain stretched relative to its 20-year history, the asset offers inflation protection and defensive properties, supporting continued strong investment flows.

In fixed income, our positioning is neutral across the board. Although the recent rise in yields has made valuations more attractive for both credit and government bonds, the immediate environment still favours selective exposure rather than a major directional move into bonds. Technical trend signals are also yet to turn positive.

The higher yields on US, UK and French government bonds are at least partially justified by greater fiscal concerns. We would like to see these concerns dissipate before increasing positions.

At the same time, the higher yields on offer in developed markets have reduced the carry offered by emerging market debt. We therefore take the opportunity to bank some profits, reducing our position in local currency bonds (ex-China) to neutral from overweight.

In credit, the focus of attention remains the boom in AI-related borrowing. We believe this creates an important supply and duration risk rather than a leverage problem. Estimates suggest that hyperscalers could account for up to 11% of US investment grade bonds by the end of next year, up from roughly 5.5% currently. With such issuers having preferred to borrow at longer maturities, they already account for a quarter of the 30-year US investment grade bucket.

The health of the credit market thus hinges on continued resilience in corporate earnings (in tech and beyond), ideally combined with a normalisation in inflation.

Corporate bonds were mixed as high-quality investment grade held up better than the weakest high-yield segments. US investment grade gained the most, ending the month up 2%, while US high yields were nearly flat. European high yields fell 1% as spreads widened sharply.

In currencies, the safe-haven Swiss franc outperformed with a gain of 1.4%. The dollar recorded a modest gain of 0.4% at the expense of the euro, which fell 1.7%. Other major developed currencies were broadly unchanged, while emerging market currencies fell some 0.5%.

Gold fell more than 6% as growing expectations of central bank interest rate hikes have made the precious metal, which offers no yield, less attractive.

^{Information, opinions and estimates contained in this document reflect a judgement at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.}