Base Case

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

75% Probability

The global economy remains on solid ground. Company profits have held up well, governments are still spending, and money is relatively easy to borrow. Encouragingly, we expect profits to keep growing into next year. That gives markets a firm base, and it is the main reason we stay broadly positive.

Even so, the risks are building. The conflict around Iran has pushed energy prices higher and disrupted the supply of essential goods such as fertiliser and industrial chemicals. The ongoing war in Ukraine adds further strain to global supply chains, the networks that move goods and materials around the world. When those networks are disrupted, costs rise and deliveries slow, which can eat into company profits. We have tilted our portfolios toward businesses with strong, lasting growth that are less exposed to these disruptions.

Inflation had been easing, but higher energy prices have pushed it back up. The difficulty is that much of today’s inflation comes from these supply problems rather than from people spending too much. Central banks are fighting it with higher interest rates, yet rate rises mainly work by cooling demand, so they are a blunt tool against a supply-driven problem. If high prices persist, the bigger danger is that they force households to cut back their spending. The risk we watch most closely is the hard combination of an economy showing early signs of cooling while inflation stays high. That mix is tougher for policymakers than either problem alone, because the usual fix for one makes the other worse.

Central banks are walking a fine line. Most cut rates last year and those benefits are still coming through, but some have started raising again as inflation picked up. In the United States, new Federal Reserve chair Kevin Warsh has signalled he will keep rates higher for longer and gradually withdraw money from the financial system, a flow we watch closely because markets need it to function smoothly. We are also seeing long-term government borrowing costs, the interest rates governments pay to borrow for many years, rise around the world. Higher long-term rates lift borrowing costs across the economy and also lower the price investors are willing to pay for each dollar of company profit, a measure known as the price-to-earnings, or P/E, ratio. When that price falls, share prices can ease even if profits hold up, and we are already seeing P/E ratios come down across the market, with the most expensive companies feeling it most. Our base case is that policy stays tighter than markets had hoped, without derailing the recovery.

Looking further out, the big growth themes remain in place. Investment in artificial intelligence (AI), manufacturing and energy should lift profits across many industries over time. We are keeping an eye on the rising cost of building AI, as the specialised chips, power and data centres involved have become far more expensive, partly due to the same energy and supply pressures. Our base case is that this raises the bill without breaking it: the companies leading the spending can afford it, and competition may bring costs down, spreading the benefits to the many businesses that use AI rather than just those that build it.

In short, resilient profits, government spending and available credit give markets a reasonable foundation, though in a more volatile setting than in recent years. September and October are historically the choppiest months for shares, more so in a US mid-term election year, so we would not be surprised by a bumpier ride, and we do not read short-term swings as a change in the bigger picture. We remain positive but are holding a little extra cash for now, ready to act if that volatility creates opportunities.