The global macro and market environment continues to be defined by a growing tension between surface-level resilience and more structural fragilities. In the United States, economic data remain broadly supportive, with headline growth holding up despite elevated uncertainty. The labour market has stabilised, easing immediate pressure on the Federal Reserve’s dual mandate and conditions remain consistent with a gradual disinflationary trend. This is reinforced by recent inflation data, where core measures are contained and underlying price pressures remain subdued outside of energy. However, beneath this resilience lies a more uneven picture. Growth is increasingly narrow and reliant on a concentrated set of drivers – most notably the artificial intelligence-led investment cycle – which continues to mask broader softness across consumption and traditional cyclical sectors.
The composition of US growth underscores this imbalance. First-quarter GDP expanded at a modest 1.6% annualised pace, with private investment contributing the bulk of the expansion, driven by a surge in AI-related spending. Investment in information processing equipment grew at an extraordinary pace, contributing nearly as much to growth as consumption. In contrast, personal consumption – still accounting for roughly 70% of the economy – has slowed materially, growing well below trend. With real wages under pressure, consumer sentiment weak and hiring momentum softening, the outlook for demand appears increasingly fragile. Outside of AI-linked activity, investment has often been flat or negative over the past two years, reinforcing the view that the expansion is increasingly concentrated and therefore more vulnerable to disruption.
At the same time, the inflation outlook has become more complex. The recent energy shock, driven by geopolitical tensions and risks to key supply routes, has introduced renewed upside risks to headline inflation. However, there is little evidence of meaningful second-order effects at this stage. Weak consumer demand is limiting firms’ ability to pass through higher input costs, and while underlying inflation measures, including trimmed mean and core indicators are trending up, inflation expectations are yet to be unanchored. This dynamic suggests a patient stance from central banks may be warranted, with the Federal Reserve expected to maintain current policy settings as it assesses the persistence of energy-driven pressures.
Against this macro backdrop, US equities have continued to demonstrate remarkable resilience, underpinned by an exceptionally strong earnings season. With almost all S&P 500 companies having reported, aggregate earnings have surprised to the upside by almost 17% – well above historical averages and marking the strongest surprise magnitude since early 2021. The blended year-on-year earnings growth rate stands at approximately 29%, the highest since Q4 2021. Earnings growth has also broadened, with 10 of 11 sectors delivering expansion and seven sectors posting double-digit gains. However, leadership remains highly concentrated. Information Technology and Communication Services dominate, with earnings growth of 54% and 49%, respectively. To put this further into perspective, within Information Technology, excluding NVIDIA and Micron would see the sector’s blended earnings growth rate fall sharply to around 30%. The concentration is even more pronounced in Communication Services, where stripping out Alphabet and Meta would shift the sector to a year-over-year earnings decline of approximately -4%.
Accordingly, the concentration of both earnings growth and market performance remains a defining feature of this cycle. While valuations have moderated from recent highs, the forward P/E ratio of 21.2x remains elevated relative to both 5-year and 10-year averages, suggesting that a degree of optimism is already embedded in prices.
Earnings have supported the recent march higher in US equities
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A critical issue with the current environment is the behaviour of cross-asset correlations. The rolling 100-day correlation between the S&P 500 and the US 10-year Treasury yield is decisively positive, reaching levels not seen since 2023. This has important implications for portfolio construction, as it undermines the traditional diversification benefits of fixed income. Importantly, the message from the bond market is becoming more difficult to ignore. Historically, bond markets have proved to be a more reliable arbiter of macro-outcomes, particularly around inflation and policy trajectories. The recent rise in yields, especially at the long end, suggests that fixed income investors are increasingly pricing in a more persistent inflation regime than is currently reflected in equities. In that sense, the bond market may be signalling that risks around energy, geopolitics and policy are being underestimated elsewhere.
Cross asset correlations are challenged
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Accordingly, the recent nine-week winning streak of the S&P 500 may suggest the rally in equities is unsustainable over the medium-term. However, a look at history suggests otherwise. Interestingly, over the past 40 years, the average forward return for all observations of markets up eight weeks in a row or more is more than 11% over the following 12 months. That said, history also reminds us that bull markets do not simply fade with age – rather, they are often “murdered by the Fed”. As such, further moves higher in yields or Fed policy should be viewed with caution.
Regionally, divergence remains pronounced. The US continues to benefit from earnings resilience and structural growth exposure, while Europe and the UK face more acute challenges from higher energy costs and margin pressure. Japan offers improving corporate fundamentals and a supportive medium-term outlook, although it remains sensitive to imported energy shocks. Emerging markets present a more differentiated opportunity set, with energy exporters and AI-linked Asian economies relatively well positioned.
Domestically, Australia is exhibiting increasingly stagflationary characteristics. Growth was already slowing prior to the escalation in geopolitical tensions, with the combination of higher energy costs, tighter monetary policy and proposed fiscal changes likely to weigh further on demand. The labour market has softened, and while inflation pressures have moderated at the margin, the economy remains highly exposed to fuel supply disruptions. We expect the RBA to remain on hold, although risks remain skewed toward further tightening.
What this means for portfolios
From a portfolio perspective, this environment argues for a balance between maintaining nuanced exposure to ongoing equity strength and building resilience against rising macro risks. We retain a modest risk-on stance, favouring US and emerging market equities, where we hold preferences for mega-cap US tech and China tech respectively. At the same time, we remain underweight regions more exposed to energy shocks, including Europe and Australia, while maintaining a modest overweight to Japan.
Within fixed income, we maintain an underweight to duration, reflecting the risk that inflation proves more persistent than currently priced.
This month we have adjusted portfolios, increasing exposure to inflation-linked bonds as a hedge, alongside an increased allocation to bank bills, which provides both attractive income and optionality. While high yield continues to offer carry, tight spreads and rising macro risks warrant a neutral stance – we have trimmed our position to benchmark accordingly. Gold has been moved to benchmark on a tactical basis amid rising real yields.