The Viewpoint: What’s next for equity markets?

The start of September marks the beginning of the home straight into the year end. Usually by now the shape of the year and its key drivers, is apparent. The main investment issues so far this year have been tariffs, defence spending, interest rates and AI.

Tariffs

Tariffs have had much less impact than expected on ‘Liberation Day’, when the US President announced what he would be charging for overseas nations to access the US market. The reason for this is that most – such as China – have been diluted down, while corporates have proven adept at routing goods through low tariff markets before sending on to the US. This does not mean tariffs will have no impact; they are ultimately a tax on US consumption which will be inflationary as well as demand reducing. However relative to initial expectations in April these have not been as serious.

Tariffs have had much less impact than expected on ‘Liberation Day’

Defence spending

Defence spending received an initial boost when Ukraine was invaded by Russia in 2022. This has been accentuated since Trump was elected, as he has demanded European countries spend more on their own defence as opposed to relying on US protection. This has resulted in proposed structural increases in defence spending in the UK and across Europe. Shares of defence industry companies have soared.

Interest rates

Interest rates are always subject to debate, but this year has been exceptional. The independence of the Federal Reserve, which sets US interest rates, has come under siege as President Trump demands lower interest rates. That he is demanding this at a time of high employment, after 53 months of  inflation above target, and with the US economy expanding, is something of a mystery. The most coherent explanation is the increasing interest rate burden on the US as deficits, plus refinancing of debt at much higher rates than five years ago, are becoming so problematic that lower interest rates are needed to cope with them. This desire to cut interest rates into a strong economy could have profound implications for investors over the coming years.

Artificial intelligence

AI remains an area subject to much debate. Since late 2022, when ChatGPT was made known to the world, AI has been a key driver of equity markets. More recently, this has been in the form of data centre expenditure which has grown at such a pace that it alone is having a material impact on overall economic growth. Alongside this has been the debate as to who will be the winners and, increasingly, who will be the losers of an AI driven world. These debates have echoes of the internet era of the late 1990s and 2000s. What is hype and what is reality? Where will capital be created and where will it be destroyed? No one truly knows, but we are certain to find out in the coming months and years. For now, markets have a positive bias to the role of AI in investment returns.

The consequence of these four factors has been much better equity markets than many expected at the start of the year, with some at all-time highs; a renaissance in the defence industry; strong performance of financials, which benefit from the perceived future interest rate environment; and fears of a new bubble forming in AI. In totality however, they have created a positive environment for equity investors. 

What next?

If that has been the story of the first eight months of the year, what will be the story of the last four? If investors have learnt one thing since the pandemic five years ago it must be the future is unpredictable. Grand theories have met hard reality and resulted in a much more different, and much more positive, investment environment than expected.

If investors have learnt one thing since the pandemic five years ago it must be the future is unpredictable

Despite trepidation to predict the future, and in the spirit of a thought experiment as to what could happen, here are a few issues that I will be keeping an eye on.

It has been a while since we had an economic crisis in the eurozone, but France may soon break this lull. With high debt and deficits, and a political construct inflexible to making difficult choices to deal with this, I think that France is moving towards some kind of fiscal crisis. The description of the situation in France of sounds very similar to that in the UK. The media in both countries talks of looming intervention from the International Monetary Fund (IMF). Autumn is the time for crises and neither France nor the UK has managed to come up with a coherent answer to the questions they face – and until they do, these governments will be subject to speculation.

The next area of interest is a world where foes and enemies are becoming friends. At a recent conference in China, Putin, Xi and Modi (the leaders of China, Russia and India respectively) were photographed in a three-way handshake. It would seem the US and its desire to place punitive tariffs on these economies have driven them into each other’s arms. Indeed, this photograph may become the defining geopolitical image of 2025. These three economies working together constitute a credible economic axis to compete with the US and Europe. Each has something the others need and have decided that past conflicts and disagreements are less important than current interests. It seems as if the world is breaking into distinct economic axes right in front of our eyes. If so, this could have profound implications for investors who are arguably entering today’s investment debates with yesterday’s answers (long US equities, long the US dollar etc).

A final area to watch is the previously mentioned AI. As an investor through the late stages of the internet bubble of the 1990s, it has been fascinating to see the (often wholly incorrect) parallels drawn between then and what we are seeing in the technology sector today. One parallel that hasn't been drawn enough, however, is between the capital destruction in the internet era and what could happen now. In the early and intermediate stages of the internet boom it was assumed that all companies would be winners, either as they were native internet businesses, or they would use the internet in ways to benefit them. In the latter stages of the internet boom, when it became a bust, it became apparent that many native internet companies (for that read native AI today) didn’t have any competitive advantage or credible business model and therefore went bust. Equally it also became apparent those few which did, now known as ‘Big-Tech’, would disrupt so many industries that it would lead to huge capital destruction in areas such as retail and media. It feels like we are now moving into the winners and losers phase of AI, and the lesson from that previous period is that avoiding the capital destruction will be at least as important as finding the winners.

It feels like we are now moving into the winners and losers phase of AI

Of course, if markets are true to form, there will be other issues that come along which no-one is predicting today: which leaves us with the thought that investing is more about adapting to change than forecasting it.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.