Is the worst behind us? Lenny McLoughlin on what comes next for markets
A Q&A with our Chief Investment Strategist, Lenny McLoughlin, on recent market moves, the Iran war, inflation, AI and portfolio positioning.
Q: Lately, markets have had a turnaround – is the worst behind us?
A: The recent equity rally to new all time highs was welcome but it was largely driven by relief versus resolution. Markets rose 7.4% over the last two weeks but the ceasefire is fragile as highlighted by events in the Strait of Hormuz over the weekend and we are watching the situation carefully and are expecting further bouts of short term volatility as markets will remain highly sensitive to developments in the Iran war and any movement towards a lasting resolution. The recovery from the lows on 30th March however was the quickest in over 75 years after an 8% correction and it is rare to revisit the lows again after such a rapid recovery to new highs.
Q: What is your overarching macro view as you look ahead?
A: Our macro anchor is one of resilient but fragmented global growth, supported by ongoing fiscal stimulus, strong consumer balance sheets and productivity gains from AI. The US remains the near‑term growth leader among developed economies, but its “exceptionalism” is expected to moderate over the medium term as fiscal pressures, ageing demographics and catch‑up from other regions build. At the same time, we are moving into a new era of self‑sufficiency, where governments accept higher costs and lower efficiency in return for greater resilience in strategic areas such as technology, energy and defence. Our base case is that the war ends soon and the global economy returns to the above trend growth path it was on earlier this year.
Q: Are there signs that the Iran war is weighing on global economic activity?
There are emerging signs of a drag on global growth from the conflict. The Global Composite PMI has fallen to its lowest level since April of last year, although it remains consistent with global growth of around 2.5%. Inflationary pressures are evident as higher oil prices have pushed the composite PMI price index to its highest level since 2023. While a short term drag on growth is expected while the conflict persists, a resolution should mean any hit to growth would be modest with the positive fundamental backdrop which existed pre the war reasserting itself through the second half of the year. The recent rise in inflation should also quickly unwind if energy prices fall following any agreement which ends the war.
Q: How has US inflation evolved and what does it mean for consumers?
US headline inflation rose 0.9% month‑on‑month in March, the largest monthly increase since January 2022, lifting the annual rate from 2.4% to 3.3% y/y. The move was driven by a 21.5% month‑on‑month jump in motor fuel prices, with overall energy costs rising 10.9% month‑on‑month.
Consumer data has been mixed. Credit card data showed US consumer spending up 4.3% year‑on‑year at the end of March and was even up 3.6% y/y excluding spending on gasoline. The University of Michigan Consumer Confidence Survey however fell to its lowest level since the survey began in 1978, reflecting high sensitivity to inflation readings. Other consumer confidence measures however were steadier in March with the Conference Board Consumer Confidence measure rising slightly.
On the activity side, the ISM Services index declined and missed expectations, but it remains consistent with US growth of over 2%. There was more positive news on investment: core capital goods orders were stronger than expected, putting real equipment spending on track for annualised growth of about 10% in Q1 while regional manufacturing indices have remained resilient through March.
Q: How is today’s environment different from 2022?
A: The current inflation set‑up and implications for central bank policy settings is quite different from 2022. Back then we had global supply bottlenecks across many sectors and regions as opposed to a single choke point now in the Strait of Hormuz; there was pent up demand as economies reopened post Covid with large levels of excess savings boosted by government subsidies; labour markets were tight; monetary policy was loose with policy rate and yields at relatively low levels. This differs to now where even in a worst case scenario of oil at $145 bl, the peak in inflation would probably be mid single digit as opposed to double digit in 2022 given the more limited set of prices pressures. Labour markets are now looser with more limited wage pressures and interest rates and yields are already higher than the starting point in 2022 meaning upside for both in a worst case scenario of persistently high oil prices should be less.
Assuming a resolution to the war is found soon, the positive pre war growth and earnings backdrop reasserting themselves should provide a path for risk assets to perform and for central banks to look through a temporary rise in inflation as wage growth and underlying inflation trends continue to move lower over time.
Q: What are expectations for corporate earnings, and what will investors focus on?
A: The Q1 earnings reporting season began just last week. Ahead of results, the usual pattern of downward revisions to earnings forecasts ahead of reporting has not occurred, despite the heightened uncertainty related to the Iran war; if anything, forecasts have been flat to slightly higher. In the week just gone, approx. 10% of US companies reported with 76% beating forecasts, well ahead of the average beat in the first week of earnings season of 68%. Results to date are 10% ahead of forecasts with upbeat comments from banks and industrial companies which were the bulk of reports. On a year‑on‑year basis, earnings growth of around 12% is expected, with a modest beat of 2–3% likely.
For investors, corporate guidance on the impact of the war and the outlook for the remainder of the year will be particularly important, as will market reaction to hyperscaler spending plans in the technology sector. In Europe, Q1 earnings are expected to have grown about 3% year‑on‑year.
Q: After a decade of US equity dominance, should investors still be so heavily tilted to the US?
A: Our starting point remains positive on US equities, reflecting the underlying economic and earnings strength in the US and AI leadership. However, we see increasing headwinds to continued US exceptionalism including relatively high valuations and an uncertain policy backdrop with signs of investors redirecting flows towards other regions. Valuations in Europe and other developed markets look more attractive, whilst competition from China and other regions is rising, especially in AI and critical materials, and there are policy risks plus the possibility that the AI “hype cycle” does not fully translate into earnings. In this environment, we believe equity exposure should be more globally balanced, with relatively more emphasis on the rest of the world – developed ex‑US and emerging markets – than in recent years.
Q: AI has been a big driver of US mega caps. How are you thinking about AI from here?
A: We see AI evolving from a narrow US mega cap story into a broader global and sectoral theme as AI is increasingly adopted and the potential productivity benefits become more evident for end users. In our framework there are three waves: the “picks‑and‑shovels” phase (semiconductors and hyperscalers), a capex arms race with infrastructure bottlenecks, and then the forthcoming adoption as AI tools roll out more widely across the economy. AI could act as a global “equaliser”, giving non‑US regions the chance to catch up in productivity and earnings over time. For investors, the challenge is to balance optimism about AI’s productivity benefits with caution around valuations and concentration risk.
Q: With higher‑for‑longer policy uncertainty, how are you positioning in fixed income?
A: Fixed income has become investible again, but with more nuance required around which part of the yield curve to own. We see long‑term government bond yields in Europe as likely to remain range‑bound with modest steepening, influenced by higher sovereign borrowing needs and quantitative tightening, reduced demand from Dutch pension reform, and offsetting foreign demand linked to attractive carry and de‑dollarisation dynamics. Strategically, we prefer to maintain duration as a diversifier, but be less concentrated in the very long end of the curve, placing more emphasis on the 5–10‑year area where the balance of yield, volatility and diversification looks more attractive.
Q: After 2022, can investors still rely on bonds as a diversifier?
A: Since 2022, equity–bond correlations have moved back into negative territory, restoring bonds’ role as a key diversifier in multi‑asset portfolios. The current conflict in the Middle East could complicate this if it were to trigger a material inflationary shock, but strategically we still see a clear role for duration as part of a diversified allocation. The positive correlation between bonds and equities since the onset of the war should prove to be temporary in nature if a resolution is found and oil prices fall and stagflation fears ease. If growth fears were to begin to dominate in a more prolonged war, we would expect bond yields to eventually begin to fall in response to a weaker growth backdrop, providing their traditional protection characteristics in a diversified portfolio.