Video transcript
Speakers
Transcript
Introduction and key themes
John: Hello, I'm John Wyn-Evans, Head of Market Analysis at Rathbones.
We have a slightly different format today for our quarterly webinar. We usually run a longer live session with a large number of slides, but we've decided to record this edition to make it more concise given the volume of developments affecting markets, particularly ahead of the upcoming Budget.
Today we'll look at global bond market concerns versus equity market strength, revisit the AI boom and whether it could become a bust, examine the UK Budget and US midterm elections, and finish with the case for maintaining a balanced and diversified portfolio.
Bond markets and rising yields
One of the defining features of this year has been a further rise in bond yields. Following the significant repricing of money and capital in 2022, the Bloomberg Global Treasuries Index has now reached an average yield of around 4%.
The last time yields were at similar levels was just before the global financial crisis and, before that, around the time of the dotcom collapse. Understandably, investors are asking whether those events could be repeated. The questions I am most frequently asked are when the next financial crisis or market crash will arrive. We've been hearing those concerns for several years, but they have not materialised and we are not currently expecting them to.
This is not solely a UK phenomenon. UK yields are among the highest in developed markets, but US yields are close behind. France has also seen a significant increase due to political and fiscal challenges, while Japan has experienced rising yields as inflation has returned after years of disinflation and deflation.
Why bond markets are under pressure
There are several reasons behind current bond market weakness. Concerns over fiscal deficits are significant, particularly in the United States, where national debt has exceeded $40 trillion, and in France, where policymakers are struggling to pass a budget while running a deficit of more than 5% of GDP.
Inflation has also reaccelerated. Energy markets have experienced renewed disruption, while shortages in refining capacity have increased prices for products such as diesel, creating pressures across transport and agriculture.
Another factor is competition for capital. This time, it may be the private sector crowding out government borrowing rather than the other way around. Major technology firms are issuing large volumes of debt to finance AI-related data centre construction.
Higher potential economic growth may also be pushing up the neutral rate of interest, increasing the floor for bond yields. In addition, investors are demanding a greater term premium to compensate for uncertainty around inflation and government deficits.
Importantly, bond yields above 5% in the UK and US are not necessarily abnormal. Historically, long-term bond yields tend to move broadly in line with nominal GDP growth. Viewed through that lens, current yields are not especially alarming.
Why equities continue to perform strongly
While higher bond yields would typically place pressure on equity valuations, global stock markets have recently reached new highs.
The primary driver has been exceptionally strong earnings growth. The United States is expected to deliver earnings growth of around 25% to 30% compared with the previous year, while markets such as Taiwan and South Korea have also benefited from strong demand linked to memory chips and AI infrastructure.
What is particularly unusual is the rapid acceleration in earnings expectations. Ordinarily, this type of earnings growth would be associated with an economy emerging from recession.
Although the S&P 500 valuation multiple has fallen from around 22 times earnings to just below 20 times, earnings forecasts have risen so quickly that the market has continued to move higher.
AI investment and technology spending
The major driver behind this earnings growth is the extraordinary level of investment by hyperscale technology companies.
Annual capital expenditure increased from around $200 billion in 2024 to approximately $800 billion in 2026. Spending is expected to exceed $1 trillion annually between 2027 and 2029.
Much of this investment is flowing to businesses providing infrastructure, semiconductors and other essential components required to support AI development.
Despite widespread discussion of AI, adoption remains relatively early. Costs continue to fall rapidly, making the technology more accessible. Historically, lower costs have encouraged wider adoption, and we expect AI to follow the same pattern.
New tools and AI agents are making the technology increasingly accessible to consumers and businesses, potentially accelerating adoption further.
Is the AI boom a bubble?
We've pushed back against claims that today's equity market resembles the dotcom bubble.
That said, there are metrics that deserve attention. Research from Morgan Stanley's Counterpoint Global team examined the proportion of stock market value derived from future growth opportunities rather than current profits. Their work suggests that more than half of the value of the US equity market depends on future cash flows.
While this is elevated, it remains below the levels reached during the dotcom era.
Other measures also provide perspective. During the technology bubble, the technology sector traded at approximately 66 times earnings. Today, valuations are closer to 20 times earnings, which appears significantly more reasonable.
Investor sentiment indicators also suggest positioning remains relatively restrained, with little evidence of excessive speculative activity across the broader equity market.
The UK Budget and fiscal challenges
Attention is now turning towards the Budget on 28 October.
Fiscal headroom has narrowed significantly, and the Chancellor will face pressure to reassure bond investors. Any additional spending is likely to require either reductions elsewhere or higher taxation.
Given commitments not to raise VAT, income tax or corporation tax, any changes may be more likely to focus on areas such as wealth or trading taxes.
Against this backdrop, advisers can play a valuable role by helping clients avoid reactive decisions and remain focused on long-term financial plans.
Our advice to the Chancellor would be simple: do no harm. We expect a relatively cautious Budget, with more difficult decisions potentially deferred until later in the parliamentary term.
The US midterm elections
In the United States, attention is focused on the congressional elections scheduled for 3 November.
Political expectations have shifted recently, particularly regarding control of the Senate. At the same time, opposition to data centre development has emerged as an election issue in some regions.
If Democrats secure both congressional chambers while President Trump remains in office, legislative gridlock could become more likely. However, negotiations around budgets and debt ceiling measures could still result in policy compromises.
Regardless of electoral outcomes, geopolitical developments are likely to remain an important driver of markets.
The case for diversification
When markets perform strongly, it is natural to feel that more risk should have been taken. Investors often ask why portfolios are not more heavily concentrated in successful sectors such as semiconductors or individual companies such as Nvidia.
The answer is that concentration can be highly rewarding when conditions are favourable, but it also exposes investors to significant risks when circumstances change.
Our role is to preserve and grow wealth over the long term, rather than maximise exposure to any single trend.
Looking at markets through different lenses
When analysing markets and economies, it helps to use multiple perspectives.
One lens focuses on current events and short-term developments. Another encourages investors to look beyond domestic headlines and identify opportunities around the world. A third, long-term perspective aligns most closely with financial planning and helps investors focus on their ultimate objectives rather than short-term distractions.
Closing thoughts
I'd like to end with a reflection from the German writer Johann Wolfgang von Goethe. Near the end of his life, he remarked: “I've had a happy life, but I can't remember a single happy week.”
That observation resonates because it reminds us how easy it is to focus on daily concerns and negative headlines. Yet over time, people often remember the positive experiences and achievements rather than the short-term volatility and uncertainty.
For long-term investors, the same principle applies. Maintaining perspective and focusing on long-term goals can help cut through short-term market noise.
Thank you very much for listening.
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