Global Head of Macro & Strategic Asset Allocation Salman Ahmed and Global Head of Multi Asset Matt Quaife analyse the drivers of recent market volatility and discuss the broader investment implications as we move into the next phase of the AI cycle. While underlying fundamentals generally remain resilient, they highlight the importance of maintaining a balanced approach to risk, with the flexibility to adapt quickly as the macro landscape shifts.
Key takeaways
- Recent AI-related market volatility is a result of changing expectations as investors now assess whether profits and productivity gains can justify the massive outlay hyperscalers are making.
- The underlying AI cycle generally remains intact and broader macro fundamentals remain more resilient than market movements might suggest.
- We are maintaining a balanced approach to risk. With several macro factors potentially reaching turning points, it is important to remain nimble and alert to opportunities as they emerge.
The recent AI-related market volatility is a result of changing investor expectations. For much of the past two years, markets have rewarded companies for capex on AI infrastructure. But now the focus is shifting onto return on investment. Investors are increasingly asking whether profits and productivity gains can justify the massive outlay the hyperscalers are making.
This transition comes against a challenging macroeconomic backdrop. Elevated bond yields are putting pressure on the valuation of long-duration assets, such as AI companies whose present value is derived from the expectation of cash flows in the future. Higher borrowing costs are squeezing the increasing amount of AI capex funded though debt, increasing scrutiny on financing even for the hyperscalers. Meanwhile, oil price volatility and persistent inflation constrain the Federal Reserve’s ability to ease policy in response to any market weakness. Geopolitical risks could intensify following the US midterm elections, while fiscal and political developments in Europe add another layer of uncertainty.
Despite the recent volatility, the underlying AI investment cycle remains intact. Our bottom-up analysts continue to see robust demand and sustained investment across the AI supply chain. However, as capital expenditure increasingly absorbs free cash flow, companies are becoming more sensitive to borrowing costs.
A sustained AI correction could have wider implications for financial conditions and economic growth. AI capex has become a dominant driver of corporate spending and economic expectations. A more prolonged cooling of sentiment towards AI could tighten financial conditions and weaken the growth outlook.
Crowded positioning and high expectations have amplified the recent volatility. We believe near-term risks have increased even though the longer-term opportunity remains. AI demand remains strong. The next phase of the AI cycle will depend on whether companies can demonstrate a return on their investments.
We remain cautiously optimistic
Although global markets are navigating a period of heightened volatility, the underlying economic fundamentals remain more resilient than recent market movements might suggest. Global growth continues to show signs of broadening, corporate earnings remain supportive, and the AI investment cycle remains intact. Importantly, our quantitative indicators are neutral rather than signalling a decisive risk-off shift, suggesting that a more balanced approach to risk is warranted.
Against this backdrop, we continue to hold a neutral stance on equities, reflecting a more finely balanced risk-reward environment rather than a fundamental deterioration in our growth outlook. While underlying demand remains robust, we expect greater differentiation between companies and sectors going forward. We remain cautiously constructive, but believe patience and selectivity are important, particularly as markets look for catalysts that could restore confidence.
Within fixed income, the recent decline in bond yields has provided some relief, but persistent inflation risks, fiscal uncertainty, and likely monetary tightening argue against aggressively extending duration. We continue to see opportunities in high yield credit, where attractive income and resilient corporate fundamentals offer a compelling source of returns.
Our priority remains maintaining diversified and resilient portfolios, while retaining the flexibility to respond as conditions evolve. With several political, geopolitical, and policy uncertainties potentially reaching important turning points, we believe it is important to remain nimble, focused on fundamentals rather than short-term noise, and prepared to take advantage of opportunities as they emerge.
