Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.

72% Probability

The conflict around Iran pushed energy prices sharply higher and disrupted the supply of essential goods such as fertiliser and sulphuric acid. The picture has since improved markedly: a ceasefire has held since April, and in June the United States and Iran signed a memorandum of understanding intended to end the conflict and reopen the Strait of Hormuz. Traffic is resuming and oil has fallen back toward the mid-70s a barrel, well below its wartime peak above $100. The recovery is real but fragile, with the deal not yet final, parts of the strait still hazardous, and the governing arrangements unresolved. We have tilted our portfolios toward companies with strong structural growth that are less exposed to any renewed supply disruption.

It is worth noting that we entered this period from a position of strength. Corporate profits were healthy, government spending was supportive, borrowing conditions were relatively easy, and oil supply was plentiful before the conflict began. These foundations give the global economy a solid base from which to recover.

Inflation had been slowing before the conflict, but rising energy prices have pushed expectations higher. In the short term, higher inflation is a headwind for both economic growth and investment returns. If it proves persistent, the greater risk becomes a slowdown in consumer spending and the kind of demand destruction that sustained high prices can cause.

Central banks face a difficult balancing act. Cutting rates can stimulate growth but risks pushing inflation higher. Raising rates can contain inflation but slows the economy. Most central banks cut rates last year and those benefits are still flowing through, but some have recently shifted back toward raising rates as inflation has picked up, creating fresh headwinds. Until we see the US Federal Reserve, European Central Bank and the Reserve Bank of Australia signal a greater focus on supporting growth over controlling inflation, we remain cautious on the outlook for interest rates.

The change of Fed leadership sharpens this caution. The new chair, Kevin Warsh, has signalled a more hawkish stance: a greater willingness to keep rates higher and to reduce the Fed’s balance sheet (the roughly $6.7 trillion of bonds it holds to influence financial conditions). Drawing that pool down withdraws money from the system and leans against both inflation and asset prices. Our base case is that this keeps policy tighter for longer than markets had hoped, reinforcing our cautious view on rates without derailing the recovery.

Liquidity levels, the flow of money that keeps financial markets functioning, remain important to watch. The wartime oil spike pulled money out of the system as income was diverted to energy costs; with prices now falling, that drain is easing. Pulling the other way is the Fed, gradually withdrawing support by reducing its balance sheet. Against that, day-to-day funding support from China and the US Treasury continues to underpin activity and commodity demand, so liquidity is now a tug of war rather than a one-way pull.

Looking further ahead, structural growth themes remain intact. Investment in artificial intelligence, manufacturing activity, and energy infrastructure is expected to broaden profit growth across industries over the medium term. One development we are watching within this theme is the rising cost of building artificial intelligence. The specialised chips, power, and data centres needed to train and run these systems have climbed sharply in price, partly on the same energy and supply pressures noted above.

Our base case is that this lifts the bill for the AI rollout without breaking it: the companies leading the investment have the cash flows to fund it, and the expected productivity gains still justify the spend. The better outcome is that competition and engineering bring costs down quickly, widening the profits available to the broader set of companies that use AI rather than just those that build it. The worse outcome is that costs stay high and investors start to question whether the sums being spent will earn an adequate return, weighing most on the highly valued technology names that have led the market.

In summary, resilient corporate earnings, government spending support, and broad availability of credit provide a reasonable foundation for investment markets, though within a more volatile environment than we have seen in recent years, which will include higher asset performance dispersion.