Taking some chips off the table

A good outlook does not mean taking every risk

There is still plenty to like about the medium-term investment outlook. The global economy is growing despite rising energy prices, higher interest rates and political uncertainty. Corporate profits are also growing, supported by the significant investment in building the infrastructure behind AI.

This is why we still have a positive view on equities. It’s also why we don’t believe we’re in an AI bubble. Demand for computing power, cloud infrastructure and advanced semiconductors is generating revenues and earnings across the technology supply chain. Over time, we believe the potential productivity benefits can extend well beyond the technology sector.

However, as the sums involved become larger, the economics deserve closer attention. Questions are increasingly being asked about how AI projects are financed, whether future revenues can justify the money being committed and what returns they can ultimately generate.

We also expect the extraordinary pace of AI spending growth to ease. As the investment base grows, maintaining the same rate of expansion requires ever larger amounts of capital. Our central scenario is therefore for spending to continue rising, but at a slower pace.

Spending can therefore grow more slowly without signalling the end of the AI investment cycle. We continue to see AI as a powerful long-term investment theme, even as the economics of individual projects and companies come under greater scrutiny. The longer-term outlook remains supportive, but the risks over the coming months have increased.

The balance of risks has shifted

There is never a dull moment on the news flow front. Cristine Lagarde’s decision to step down as European Central Bank President in February 2027, nine months before the end of her term, might add some uncertainty in the near term. However, it also allows current European leaders to choose her successor. At the same time, the French elections could continue to grab market attention, putting upward pressure on bond yields if no credible path towards fiscal adjustment and economic reform emerges.

More fundamentally, one area where the outlook has become less favourable is energy. The decline in oil prices we had anticipated as tensions in the Middle East eased has not materialised. A further disruption could send energy prices higher, putting renewed pressure on inflation, household finances and company costs while making central-bank decisions more difficult.

The approaching US midterm elections introduce another source of uncertainty. A more divided government could constrain further fiscal expansion, while the political consequences of the result could also shape US foreign policy and negotiations in the Middle East.

Neither development overturns our central economic outlook. But they come at a time when several markets have already risen substantially, raising the hurdle for taking additional risk. Investors need to consider not only what is most likely to happen, but how much optimism is already reflected in prices and whether the potential return still provides sufficient compensation if events develop differently.

This is where our view on emerging markets has changed.

Why we are taking profits in emerging markets

Our overweight position in emerging market equities has performed well. Improving earnings, strong Asian markets and exposure to the global technology cycle have all helped.

We are now taking some profits and returning to a neutral position. But we are not walking away from emerging markets.

We still see attractive long-term opportunities, particularly in Asian technology companies and the semiconductor supply chain. We also remain positive on the longer-term AI investment cycle. However, there are two reasons why we think the near-term balance between risk and potential return has become less attractive.

Firstly, technology makes up a large part of the emerging market equity universe. That exposure has supported performance as AI investment has grown, while giving investors another way to participate in the theme beyond the large US technology companies. But it also means US and Asian technology markets are increasingly exposed to the same questions from investors about AI spending and the returns it can ultimately generate.

Secondly, many of the Asian markets we invest in are particularly exposed to higher oil prices. The largest Asian emerging markets are oil importers, making them vulnerable to a further rise in prices if tensions in the Middle East escalate. If that were accompanied by a stronger US dollar or investors pulling money out of emerging markets, the pressure could become more pronounced.

Being positive about emerging markets over several years does not mean maintaining an overweight position at every point in the cycle. For now, we believe a neutral allocation is more appropriate.