Back to school (again)

With market participants returning from the summer break, liquidity is improving and sentiment remains broadly constructive. Equities extended their rally through July and August, despite occasional bouts of volatility and headlines pointing to an uncertain outlook. Our portfolios benefited from this environment, supported by a measured preference for equities over bonds. Growth is still positive, though slowing, and expected rate cuts from central banks such as the US Federal Reserve (Fed) should provide an additional tailwind. At the same time, we keep our equity preference moderate and maintain broad diversification to guard against risks ranging from geopolitics, inflation and trade tariffs to elevated valuations and market concentration in the US.

Within equities, we remain close to benchmark allocations in the US but have tilted part of the exposure into an equal-weighted index. This approach gives greater weight to attractively valued sectors such as financials and industrials, which could benefit from US fiscal stimulus and deregulation. We also hold tactical overweight positions in European, Japanese and emerging-market equities. These regions offer more compelling valuations and specific growth drivers, including defence and infrastructure spending in Europe, corporate reforms in Japan and an improving earnings backdrop in emerging markets. A weaker US dollar could also prove supportive.

In fixed income, the approval of higher US budget spending and rising government debt levels have prompted greater caution. We prefer European and UK sovereign bonds (for euro and sterling portfolios, respectively) over US Treasuries, and European corporate bonds over their US counterparts. We also keep a reduced exposure to the US dollar, given the risk of further weakness.

To manage risks, we retain a diversified set of mitigators. We see scope for a mild stagflationary episode in the US, where slowing growth coincides with sticky inflation. Accordingly, we hold commodities and inflation-protected bonds. Geopolitical risks and potential growth scars argue for overweight allocations to gold and minimum-volatility equities, which tend to hold up better during volatile markets.

Our outlook remains that the Fed will lower rates in September, with a likely further reduction in December. At the Jackson Hole policy gathering, Chair Powell has indicated that slowing job growth could warrant rate cuts even as inflation risks linger. Markets reacted swiftly: yields fell, the dollar softened and equities rallied on expectations of a September shift. Yet rising political tensions complicate the picture. President Trump has openly criticized the Fed and could name Powell’s successor well before his term ends in May 2026, raising concerns about central bank independence. This risk reinforces our cautious stance on US sovereign assets such as Treasuries and the dollar, despite the potential support from Fed cuts.

Meanwhile, Nvidia’s results reaffirmed the structural case for AI. Earnings broadly beat expectations, with guidance pointing to accelerating demand for infrastructure. Despite modest caveats—such as slightly weaker data center revenues and ongoing US-China tensions—the AI theme remains central to long-term capital allocation. US equities continue to offer exposure to this structural driver, alongside thematic investments in digital transformation.

In Europe, political risk is re-emerging but remains contained. France faces a parliamentary vote of confidence on 8 September. While political noise may unsettle sentiment, Europe’s institutional framework and continued fiscal support, including defence and infrastructure spending, mitigate risks and provide resilience.

September is historically the most volatile month for equities, and the Fed’s 17 September meeting will be pivotal. Before then, incoming data will help shape expectations. ISM surveys for US manufacturing (Tuesday) and services (Thursday) will give fresh insights into activity, costs and hiring. US factory orders (Wednesday) and the trade balance (Thursday) will reflect ongoing tariff uncertainty. Most critical will be Friday’s August labour market report, with consensus expecting payroll growth of around 78,000—ongoing job creation, but consistent with a cooling job market.

Across Europe, attention will be on preliminary inflation data for August (Tuesday). Headline inflation is expected to stay near the European Central Bank’s 2% target, easing pressure for immediate action. In the UK, August retail sales (Friday) should provide further evidence of softer consumer momentum, consistent with weaker sentiment.