Markets in risk-on territory

Chairman of the Fed, Jerome Powell, stated recently that economic prospects have remained unchanged since September. At that time, the Fed cut interest rates by 25 basis points due to concerns about the labour market. The market consensus is that the Fed will cut rates two more times this year, and Powell has not pushed back on this expectation.

This suggests a more dovish Fed and has led to a revision of our baseline scenario, which now predicts rate cuts in October and December, followed by an additional 75 basis points reduction in 2026. However, US monetary and fiscal easing could heighten inflation risks, particularly due to demand-driven inflation and import tariffs, and then rate cuts may be less likely. In Europe, the European Central Bank (ECB) appears to have paused rate cuts for now, as attention shifts to the anticipated German ‘fiscal bazooka.’ This includes investments in defence and infrastructure, which are expected to positively impact the German and European economies in the fourth quarter and in 2026.

We are at the start of a highly anticipated earnings season. The equity rally over the summer has led to stretched valuations, as some say that the market is approaching bubble territory. This is especially the case for the AI related tech stocks in the US. Therefore, negative earnings surprises could lead to a sharper than usual pullback. This was also the case, when US President Donald Trump reignited trade-war concerns by announcing higher import tariffs on China.

Despite this, we believe that equity markets are currently still in a risk-on scenario. In the US, earnings growth for the third quarter is expected to be solid while the expected Fed rate cuts can provide additional support for the economy. The strong profitability and earnings growth of companies indicates that we are in fact not in a bubble. In Europe, the expected earnings growth for the third quarter is expected to be significantly below that of the US, but still positive. Additionally, the upcoming ‘fiscal bazooka’ will provide support for European equity markets. As a result, we remain confident with our modest overweight positioning in equities.

We have had a negative view on high-return bonds, that consist of emerging market debt (EMD) and high yield bonds. Now we are becoming slightly less negative about the asset class and about EMD in particular. The macroeconomic backdrop has been improving over the last months. The US economy remains more resilient than expected and some worst-case scenarios (e.g. escalating tariff wars, US stepping out of NATO, escalating Middle East conflict), now seem less likely. In this environment, emerging markets have performed well.

Fiscal consolidation, stronger external balances and proactive monetary policies have reinforced emerging market sovereign credit metrics, as reflected by improving credit ratings. Additionally, with a structurally weaker dollar and Fed rate cuts, this positive trend has further to go. Fed rate cuts and dollar weakness help alleviate external debt pressures for sovereigns, particularly those with high external debt exposure. Furthermore, GDP growth in emerging markets is expected to outpace that of developed markets by a decent margin.

This growth differential is a key tailwind for EMD, and historically such environments have been strongly correlated with EMD outperformance. Finally, the asset class should continue to benefit from strong risk sentiment among investors, helped by attractive yields driving inflows. Therefore, we are closing our underweight position in EMD while maintaining a modest underweight in HY debt in general. We continue to have a positive view on bonds in general and high-quality bonds in particular.

Financial markets performed well over the summer, which has led to stretched equity valuations. Although this makes markets more susceptible to negative surprises, we believe that the current macroeconomic environment is supportive for a continuation of the rally. Fed rate cuts and strong earnings growth expectations in the US, and a ‘fiscal bazooka’ in Europe support our modest overweight in equities. In our bond portfolio, we are closing the underweight position in EMD as emerging markets are experiencing several tailwinds while simultaneously offering more attractive yields than cash and sovereign bonds.

Richard de Groot 
Chair Global Investment Committee