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 conflict around Iran pushed energy prices sharply higher and continues to disrupt the supply of essential goods such as fertiliser and sulphuric acid. The picture remains volatile: on-again/off-again ceasefires, the deal not yet final, parts of the strait still hazardous, and governing arrangements unresolved. We have tilted portfolios toward companies with strong structural growth that are less exposed to any renewed supply disruption.

While risks abound, the global economy, credit markets and corporate profits remain on a solid footing. Earnings are resilient, government spending supportive, and borrowing conditions relatively easy, giving the economy a solid base from which to grow. That said, the next two months carry their own seasonal weather: September and October are historically the year’s most volatile for shares, and in a US mid-term election year the uncertainty is sharper still. We would not be surprised by choppier markets, and we do not read short-term swings as a change in the underlying picture.

Inflation had been slowing before the conflict, but rising energy prices have pushed expectations higher. Higher inflation is a near-term headwind for growth and returns; if it persists, the greater risk is a slowdown in consumer spending and the demand destruction that sustained high prices can cause. The recent downward surprises in Australia and the US are encouraging, but we are increasingly alert to the harder combination of a global economy showing early signs of cooling while inflation stays elevated. That mix is tougher for policymakers than either problem alone, because the usual remedy for one worsens the other, and it is the persistent risk we watch most closely.

Central banks face a difficult balancing act. Cutting rates stimulates growth but risks inflation; raising them contains inflation but slows the economy. Most cut last year and those benefits are still flowing through, but some have shifted back toward raising rates as inflation has picked up, creating fresh headwinds. Until the US Federal Reserve, European Central Bank and Reserve Bank of Australia signal a greater focus on supporting growth over controlling inflation, we remain cautious on rates.

The change of Fed leadership sharpens this caution. 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. 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, without derailing the recovery.

Liquidity, the flow of money that keeps markets functioning, remains important to watch. Rising oil prices reduce it; conditions remain benign, though a recent slowing in liquidity growth concerns us. With government and corporate debt so elevated, an excessive slowing could trigger credit-market dysfunction. This is on watch, not a live concern for now.

Looking further ahead, structural growth themes remain intact. Investment in artificial intelligence, manufacturing and energy infrastructure should broaden profit growth across industries over the medium term. Within that theme, we are watching the rising cost of building AI: the specialised chips, power and data centres needed to train and run these systems have climbed sharply, 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, albeit with more debt, and the expected productivity gains still justify the spend. Better still, competition and engineering may 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 question whether the spend will earn an adequate return, weighing most on the highly valued technology names that have led the market. This matters because so much capital, both equity and credit, has been committed to the buildout that it has become systemically important.

In summary, resilient earnings, government spending and broad credit availability provide a reasonable foundation for markets, though in a more volatile environment than recent years, with higher dispersion in returns. With a seasonally weaker patch ahead and the tension between softening growth and sticky inflation unresolved, we remain constructive on risk assets but continue to hold slightly higher cash for now, ready to act should that volatility create opportunities.