Anyone following the headlines would have expected financial markets to have endured a difficult period. Geopolitical tensions escalated, the conflict in the Middle East created uncertainty around energy supplies, and central banks continued to warn of persistent inflation. Yet whilst public attention in June focused on risks, the underlying fundamentals of the global economy improved.

 

What is particularly striking is that global economic growth is becoming increasingly broad-based. Asian economies are benefiting significantly from investment in artificial intelligence and digital infrastructure. Taiwan recorded growth of 14.3% in the first quarter, the South Korean economy accelerated to 3.8%, and Japan is also benefiting from a combination of reforms, investment and improving corporate earnings. At the same time, Europe is experiencing the emergence of a new investment cycle centered on defense, automation, and energy infrastructure for the first time in many years. Europe deserves more attention than it has received in recent years. The region is not merely benefiting from lower energy prices. Defense expenditure increased to almost USD 563 billion last year and now accounts for more than 21% of global defense spending. Driven by geopolitical tensions, Europe is also investing heavily in automation, digitalization, infrastructure, and energy networks. As a result, Europe is developing several structural growth drivers that could support economic expansion for many years to come.

 

Equity markets are benefiting from this combination of diminishing risks and stable global growth. During the first half of the year, the MSCI World Index (developed markets), measured in euros, rose by 11.9%. The MSCI Emerging Markets Index gained an impressive 26%, whilst Japan’s TOPIX Index delivered a return of 16.1%. What is particularly noteworthy is that the equity market rally is becoming increasingly broad-based. Until recently, investment returns were largely driven by a small group of major, predominantly American, technology companies. We are now seeing earnings growth spread across other sectors and regions. This makes the current market cycle more resilient. At the same time, the first critical questions are emerging regarding the returns generated by the substantial investments being made in AI infrastructure at an extraordinary pace. This occasionally results in more volatile trading days. Nevertheless, we believe that a broader economic foundation is ultimately healthier than a market dependent on only a handful of winners.

 

The outlook for bonds is less pronounced than for equities. Falling inflationary pressures are supportive, but central banks are seeking greater confidence before materially softening their stance. As a consequence, long-term government bond yields have remained relatively stable. The yield on the 10-year US Treasury stands at 4.44%, whilst the German 10-year Bund yield is at 2.91%.

 

Gold provided a contrarian signal this month. Despite ongoing geopolitical tensions, the gold price fell by more than 10%. This illustrates that gold does not automatically appreciate when uncertainty increases. The level and direction of real interest rates also play an important role.

 

Geopolitical tensions could flare up again, and monetary policy remains a source of uncertainty. However, investing is ultimately about the balance between risk and return. Lower energy prices, easing inflationary pressures and a broadening of economic growth mean that the foundations underpinning financial markets appear stronger than they did only a few months ago. Furthermore, growth is increasingly spreading beyond American technology companies to Asia, emerging markets, and parts of Europe.

It is precisely this broader foundation that gives us confidence that the current economic cycle still possesses sufficient momentum. As a result, we are using our cash holdings to increase our exposure to equities.

 

Please find attached our last Asset Allocation Update for July.