Despite a challenging backdrop of resurgent geopolitical tensions, high energy prices and the sharpest rise in capital market yields in years, global equities on balance showed impressive resilience, with share prices remaining close to recent record highs over the past month.

At regional and index level, however, the picture was highly fragmented. The tech-heavy US S&P 500 index edged down 0.3% in September, but its equal-weighted counterpart fell 4.8%, showing how dependent market performance is on a small group of large technology companies. In Europe, the STOXX Europe 600 index fell 3.0%, weighed down by the proximity of the Middle East conflict and higher energy costs. Chinese equities fell 4.5% amid ongoing macroeconomic headwinds. Japanese equities were unchanged in September and gained 2.6% over the quarter. Emerging market equities fell only 0.5%, supported by a cyclical economic recovery and upward earnings revisions in the Asian semiconductor supply chain.

The macroeconomic context shows the hallmarks of a late-cycle economy, in which a robust industrial upturn coincides with persistent upward price pressure. US consumer confidence fell to its lowest level since 2014, and higher-income households are adjusting their spending under the pressure of sustained inflation. The European economy, by contrast, is showing remarkable resilience, with the composite purchasing managers' index rising to 53.1. A reading above 50 indicates an expanding economy.

Central banks felt compelled to tighten monetary policy further in response to rising energy prices. The US Federal Reserve raised its policy rate by 25 basis points to a target range of 3.75% to 4.00%, following the European Central Bank, which also raised its deposit rate by 25 basis points. Eurozone inflation rose to 3.8% in September, whilst US inflation stood at 3.4% in August. The market is pricing in further rate hikes, and the rise in capital market yields is driven not so much by higher inflation expectations as by a sharp increase in real interest rates. Rising real yields and widening government deficits led to substantial losses on long-dated bonds. US Treasuries lost 2.2% in September, with the ten-year yield climbing to 5.3%, while German and French ten-year yields also rose. The spread between French and German government bonds now stands at 141 basis points, the highest risk premium since the European debt crisis of 2012, driven by political deadlock over French fiscal reform.

In commodity markets, the Middle East conflict and the continued blockade of the Strait of Hormuz pushed the price of Brent crude up 16% in September to 103.56 dollars per barrel. Refined products such as diesel, petrol and jet fuel rose even faster, pushing up fuel prices. Base metals benefited from robust industrial demand and the construction of data centers. Gold, by contrast, fell sharply in September to 4,164 dollars per troy ounce, weighed down by rising real interest rates.

The global economy has proven resilient to geopolitical tensions, and leading indicators point to continued growth. Headline inflation has ticked up on the back of higher energy prices, but underlying inflation is not developing in a way that would force central banks to intervene aggressively. Thanks to solid economic growth, analysts worldwide are revising their earnings estimates sharply upwards. In the US, estimates have risen by around 15% since the start of the year, and in emerging markets twelve-month forward earnings expectations are up by as much as 80%. Because earnings expectations are rising faster than share prices, price-to-earnings ratios have come down, and there is no sign of overheated sentiment. We therefore maintain a slight preference for equities over bonds, as earnings growth should continue to support share prices over the longer term.

Please find attached our last Asset Allocation Update for October.