Macro Matters: Markets Move Post-U.S. Midterms

Recent market moves

In our view, the recent sell-off in U.S. equities was as much about an exceptionally poor technical setup and forced re-hedging by market participants as it was about a deterioration in fundamentals. The near-term tail risks remain elevated, with more positioning to work through. However, the Democratic sweep changes the distribution of policy risks and may drive sentiment.

The massive investment in AI and the return on that investment have been under scrutiny for months at this point. The fundamentals argue for greater scrutiny of large technology platforms, data centers, and infrastructure supporting AI, particularly around power consumption, permitting, data use, and local infrastructure. This could slow the buildout and add regulatory or tax burdens, but we believe it is unlikely to stop it entirely. The relatively large market moves in recent days appear to be more technically driven at this stage. Typical proxies and broader parts of the equity market have been relatively resilient, and neither suggests that the recent moves are indicative of a broader "growth scare" or "inflation scare."

We believe it is becoming increasingly clear that market participants had reduced hedges following the midterms, only to reestablish them yesterday, helping drive these moves. Thursday saw the highest put option volume in history, with “Tariff Day” (April 4, 2025) a close second. While the technical backdrop matters tremendously in the short term, we argue for patience over a longer horizon. Excess liquidity has been shrinking on both the fiscal and monetary sides; the yield curve has flattened, and financial conditions have tightened over 2026. In the same vein, positioning in the AI theme has been crowded, and we have not yet seen the kind of broad capitulation that would normally give us greater confidence that the unwind is complete.

Our economic outlook

In our view, the global economy is showing increasing signs of being late in the economic cycle. In the U.S., growth remains above trend but is gradually losing momentum, with a softer labor market evident in weaker participation, volatile payrolls, and slowing wage growth. Inflation is beginning to reaccelerate, largely reflecting supply-side pressures, although favorable base effects should provide some cushion through the first half of 2027. At the same time, financial conditions remain restrictive, with large fiscal deficits, AI-related capital spending, and tighter monetary policy keeping sustained pressure on longer-term interest rates. The AI investment cycle remains an important support for activity, but its contribution to growth is likely to peak in late 2026 or early 2027.

The U.S. midterm elections shifted control of both chambers of Congress, resulting in a divided government beginning in January. This adds another dimension to our outlook. We expect to see a higher level of scrutiny of capital expenditure depreciation, tariffs, and defense spending. Higher taxes appear unlikely in the near term, though Democrats may begin laying the groundwork for potential changes in 2028. A narrower fiscal deficit could be supportive for bond investors.

The election results could also reshape the investment and sector backdrop. Critical examination of AI investment incentives and data center development could raise costs and slow the pace of the AI buildout while potentially improving capital discipline and credit profiles among hyperscalers and other AI providers. Health care and financials may face greater policy scrutiny, while consumer-oriented sectors could benefit from potential tariff relief. Taken together, these shifts reinforce the case for greater selectivity across markets as investors assess the implications of a changing fiscal, regulatory, and monetary policy environment.

Elsewhere, other developed economies face a similar but more challenging mix of weaker growth, softer labor markets, and persistent inflation pressures, without the same degree of growth support that the U.S. has benefited from. Geopolitical risk remains prominent across the major economies, with higher energy prices representing the primary transmission channel to inflation, growth, and ultimately monetary policy. China remains the notable exception, with policymakers pursuing countercyclical easing in response to persistent deflationary pressures. All together, we see a global economy that is slowing rather than contracting, but with narrowing sources of growth and less room for policy error. We believe that despite near-term inflation risks, softer activity and restrictive financial conditions should ultimately allow central banks to deliver fewer hikes than markets currently price.

Prospective changes to asset allocation

• Equities
  We maintain a neutral view on equities, balancing resilient earnings against a more uncertain macroeconomic and geopolitical backdrop. Elevated real yields remain a consideration, while expectations around the AI investment cycle continue to influence the broader technology sector. Investor attention is increasingly shifting from the scale of AI-related capital expenditure to the returns generated by that investment, including its contribution to revenues, margins, and earnings per share. This suggests expectations are becoming more demanding, even as the underlying investment cycle remains robust.
  
• Fixed income
  We remain neutral overall on fixed income but see greater relative value opportunities within the asset class. We have used recent spread widening to add selectively to high yield, funded from investment-grade credit and sovereign bonds. Within sovereigns, we remain neutral on overall duration, preferring to express views through cross-country positioning. Global real yields remain attractive, but persistent inflation pressures and diverging growth trajectories argue for greater selectivity. We are favoring sovereign debt from Japan, Australia, and Canada, albeit for different reasons. Japan is supported primarily by technical factors, despite the country’s normalizing monetary policy. In Australia, the rate-hiking cycle is more advanced and the outlook is increasingly driven by growth. In Canada, softer growth and comparatively contained inflation pressures provide a different source of opportunity.
  
• Commodities and foreign exchange
  We remain neutral on commodities while broadening our opportunity set within the asset class. In energy, persistent geopolitical uncertainty leads us to favor relative value opportunities over outright directional exposure. We also favor industrial metals and retain a modest overweight to agricultural commodities, despite some softening in underlying fundamentals. Within currencies, we remain positive on select economies where favorable growth dynamics, orthodox monetary policy, and attractive starting rates provide support.
  

Multi-asset allocation views

These multi-asset views reflect tilts to our strategic asset allocation models and are based on a 6- to 12-month time horizon, driven by both quantitative and fundamental research.
+ (Overweight on overall asset class)    
= (Neutral on overall asset class)  
– (Underweight on overall asset class)

Forward investment implications

Carry refers to the net return earned from holding an asset over time, independent of price movements, after accounting for the costs of financing or maintaining that position.

Curve steepener refers to a change in the yield curve where the difference between long-term interest rates and short-term interest rates increases, making the yield curve steeper.

Duration is a measurement of the sensitivity of a bond’s price to changes in Treasury yields. A fund’s duration is the weighted average of duration of the bonds in the portfolio. Duration should be interpreted as the approximate change in a bond’s (or fund’s) price for a 100-basis-point change in Treasury yields. Duration is based on historical performance and does not represent future results.

Hedging a security means using a separate investment to offset the potential risks of that given security.

Hyperscalers are large tech companies that provide cloud-computing infrastructure to the AI labs.

The Nikkei Stock Average (Nikkei 225) is composed of 225 stocks selected from domestic common stocks in the first section of the Tokyo Stock Exchange and is a leading benchmark for Japanese equities.

The Personal Consumption Expenditures (PCE) Price Index reflects changes in the prices of goods and services purchased by consumers in the U.S. It is part of the Personal Income and Outlays Report issued by the Bureau of Economic Analysis of the U.S. Department of Commerce. You cannot invest directly in an index.

Purchasing Managers’ Index (PMI) is an economic indicator that measures the health of a country’s manufacturing or services sector.

A put option is an options contract that gives the holder the right, but not the obligation, to sell an asset at a specified price within a specified period.

Real yield can be defined as the nominal yield that is received from an investment after accounting for the 

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Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

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