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Looking back at October’s dataflow and what it may mean for portfolio positioning.
October tested markets on two fronts. Long-term borrowing costs climbed to multi-decade highs across the US, Europe, the UK, Japan and Australia, while inflation came in hotter than expected in Australia, the US and the UK. Brent crude rose back above US$116 a barrel after Houthi strikes on Saudi energy sites.
Growth data was mixed rather than weak. US layoffs stayed near multi-decade lows and business surveys pointed to healthy expansion, China’s economy beat forecasts on surging exports, and AI investment showed no sign of slowing. Australia was the soft spot, with 39,300 jobs lost in September and unemployment at 4.7% as inflation rose to 4.3%.
The difficult mix we have been watching is now visible in Australia: a cooling economy alongside inflation that is still rising
Supportive signals
Watch-outs
October’s defining move was in bond markets. Long-term government borrowing costs reached multi-decade highs across the US, France, the UK, Japan and Australia as inflation surprised to the upside and oil climbed back above US$116. Higher long-term rates lift borrowing costs across the economy and lower the price investors will pay for each dollar of company profit.
Growth held up unevenly. US layoffs stayed low but September hiring slowed sharply, and China’s headline beat masked soft domestic demand. Australia is where the tension is clearest: inflation at 4.3% and a fifth rate rise this year on 3 November, alongside falling employment and consumer confidence near record lows. That is the combination of a cooling economy and stubborn inflation we watch most closely, because the usual fix for one worsens the other.
Equities: Profits have held up and we expect them to keep growing into next year. AI investment shows no sign of a pullback, but more of it is now borrowed. We favour companies that can fund the build-out from profits and the businesses supplying the power, equipment and infrastructure it relies on. In Australia, we remain cautious on businesses that depend on discretionary spending such as retail and dining out.
Fixed income: The global sell-off is the key change, lifting borrowing costs everywhere and putting pressure on share valuations. France is the pressure point to watch: its 10-year yield rose above 5% and its gap over Germany reached the widest since 2011. Our base case is that this stays a French problem, with the ECB able to step in if needed. Lower down the credit spectrum, spreads on the lowest-rated bonds have widened sharply as lending to weaker borrowers keeps growing.
Alternatives and real assets: Oil remains the swing factor. Brent rose to a six-month high after Houthi strikes on Saudi energy sites, shipping through Hormuz is still a fraction of pre-war levels, and the conflict continues to disrupt supplies of essentials such as fertiliser and industrial chemicals.
FX: A stronger US dollar has added to tighter financial conditions, while the euro slid towards a 17-month low as France’s turmoil deepened.
Resilient profits, government spending and available credit give markets a reasonable foundation, but a constructive base case does not mean a smooth ride.
Practical implications:
Scenario probabilities reflect our current assessment and are reviewed as new data emerges.
Base case: 75% probability
The global economy remains on solid ground. Company profits have held up well, governments are still spending and money remains relatively easy to borrow. We expect profits to keep growing into next year, which gives markets a firm base and is the main reason we stay broadly positive. Even so, risks are building. The Iran conflict has pushed energy prices higher and disrupted supplies of essentials such as fertiliser and industrial chemicals, while the war in Ukraine adds further strain to global supply chains, so we have tilted portfolios toward businesses with strong, lasting growth that are less exposed.
Inflation had been easing, but higher energy prices have pushed it back up, and rate rises are a blunt tool against supply-driven price pressure. Australia is a clear example of the cooling-economy, high-inflation mix we watch most closely: inflation rose to 4.3% and the RBA lifted rates for a fifth time this year on 3 November. With mortgage repayments climbing and consumer confidence near record lows, households are cutting back on non-essentials, and we remain cautious on businesses that depend on them. Fed Chair Kevin Warsh has signalled US rates will stay higher for longer as he gradually withdraws money from the financial system, and long-term borrowing costs are rising worldwide, lowering the price-to-earnings (P/E) ratio investors will pay. France is the pressure point, with 10-year borrowing costs above 5% and its gap over Germany the widest since the 2011 euro debt crisis. Our base case is that this stays a French problem.
AI spending remains the biggest driver of business investment and market gains, with the largest technology companies on track to spend close to US$800 billion this year. October results showed no sign of a pullback: Microsoft’s cloud business grew 48% and Alphabet flagged a significant rise in spending next year. What has changed is the funding. More is now borrowed, and the cost of insuring AI-linked debt against default, measured by credit default swaps, has hit record highs for companies including Oracle, Alphabet and Meta. We expect spending to continue, led by companies that can fund it from profits.
Democrats performed strongly in the 3 November US midterm elections. Democrats won control of both the Senate and the House. Markets may read the result as a negative for data centre construction and demand for AI infrastructure. We are taking a more balanced approach for now and prefer not to jump to conclusions on policy. A divided Washington most likely means two years of gridlock with President Trump: fewer new policies, but less room for large new spending or tax cuts, which could ease pressure on bond markets. More gridlock in Washington is generally seen as a positive by markets. We remain positive but hold a little extra cash, ready to act if volatility creates opportunities.
Bear case: 13% probability
The main risk is a real pullback in spending by households and businesses, especially in the United States, at a time when share prices are already high relative to profits. AI is the trigger to watch. If the rising cost of insuring AI-linked debt spreads from the most indebted players to the large technology companies, borrowing would become harder and spending plans could be cut quickly, hitting the economy and share prices at once. With market gains leaning on a few expensive technology companies, a sharp fall in those leaders could drag the whole market down.
Sustained oil price rises and worsening supply-chain disruption from the wars in Iran and Ukraine would add pressure, and with inflation largely supply-driven, central banks may be unable to cut while high government debt limits fiscal support. France’s debt troubles could also spread, lifting borrowing costs in other heavily indebted countries, including Italy, the UK, Japan and the US, and squeezing share prices even if earnings hold. A bitter stand-off between Congress and the White House leading to government shutdowns would add uncertainty.
Closer to home, the RBA may need to keep lifting rates, forcing stretched households to cut spending harder and tipping the economy toward recession. China adds risk too: if its property market weakens further and support fails to restore confidence, lower demand for our resource exports would hit national income and company profits directly. Here we would turn more defensive, with more cash, less exposure to shares and a tilt toward healthcare, consumer staples and utilities.
Bull case: 12% probability
In the bull case, tensions with Iran ease and the pressures on markets turn supportive. Falling energy prices, easing supply-chain strains and better diplomatic relations, including progress in Ukraine, would support stronger growth while keeping inflation in check. At best, ceasefires hold, the Strait of Hormuz reopens fully and recovery follows, and resolving trade disputes would lift profits as costs fall and consumers keep spending.
If markets trust that inflation is under control, long-term borrowing costs can fall even while the Fed holds rates steady, lifting the price investors pay for each dollar of profit. A credible French budget would narrow the gap over German borrowing costs, and gridlock in Washington after the midterms would limit new government borrowing. If AI spending keeps delivering profits like October’s rapid cloud growth, debt worries would ease, credit markets would calm and the benefits would spread to the many companies that use AI rather than the few that build it.
For Australia, if inflation peaks soon and the RBA can stop raising rates, pressure on household budgets would ease and spending would recover, while relatively low public debt gives policymakers room to do more. Here we would favour a growth-focused portfolio with less cash and more exposure to industrials, materials and financials.
October’s message came from the bond market. Long-term borrowing costs rose to multi-decade highs as inflation surprised to the upside in Australia, the US and the UK, and oil climbed back above US$116. Growth is holding up unevenly, with Australia showing the clearest strain. We remain positive on the strength of company profits, tilted toward businesses with strong, lasting growth and companies that fund AI investment from profits, and are holding a little extra cash while volatility stays high.
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