Two themes continue to dominate: Geopolitics and Technology 

The US - Iran war has reached an uneasy and uncertain ceasefire as neither side seems keen on continuing major hostilities. Despite some occasional exchanges of missiles, the oil price has declined from a peak of US$120 per barrel in May to US$74 at the quarter-end, effectively the same price as just before the outbreak of hostilities. This is despite the fact that supplies from the Gulf will remain materially below pre war volumes for sometime. Whilst the ability of non-Gulf producers to increase supply and the drawdown of strategic reserves was expected the surprise has been the substantial decline in Chinese import volumes. China continued to export distillates to “friendly” countries, implying that China’s reserves were much greater than forecast and correspondingly underlying demand is lower than forecast. 

The net effect is that the supply and price shock from the disruption to oil supplies has not been as severe as feared and as long as the ceasefire holds and supply volumes recover we expect there will be a return to surplus and lower oil prices in the long run. However, while the risk of an energy-driven inflation spike has diminished, broader inflationary pressures remain persistent, and inflation is still likely to settle above central bank targets for some time. 

The other theme remains centred around the impact of the AI infrastructure boom. Investor focus has shifted from the hyperscalers - Meta, Microsoft, Amazon, Alphabet (Google) and Oracle to the next tier of companies that will benefit from the truly massive capital expenditure(Capex) plans. The main beneficiaries have been the chip and memory producers such as Samsung, SK Hynix, Intel, SanDisk and TSMC. Whilst these companies have seen explosive earnings growth their share price performance has been even more explosive. In fact, almost all the gains in global equity markets over the second quarter were driven by the AI theme. 

Limited space precludes us from going into detail, but we are increasingly concerned by the circularity and interconnectedness of the AI theme. Notably the fact that the hyperscalers which used to generate huge amounts of free cash flow are now spending so much that they are borrowing significant sums by issuing bonds and many of the large companies are investing each other, in effect providing capital to buy their own products. 

We have often mentioned that asset prices are driven by the balance (or imbalance) between buyers and sellers. For many years, we have had a backdrop where the number of shares in issue in developed markets is declining due to takeovers and share buy-backs. This year will be the first for many years where equity issuance through IPOs such as SpaceX (raising US$85bn) and the upcoming IPOs of OpenAI (US$60bn), and Anthropic (US$60bn) will result in net new equity issuance. 

Meanwhile, the new Chair of the US Federal Reserve (Fed) Kevin Warsh has often spoken about shrinking the Fed’s balance sheet, which effectively drains liquidity from the financial system. At the moment FOMO (Fear of Missing Out) is driving retail flows but a mood shift, a combination of declining liquidity, net equity issuance, and large bond issuance has the potential to shift the balance between buyers and sellers and is not a good backdrop for asset markets. 

We have not changed our stance from Q1. We prefer to be cautiously positioned and potentially miss some upside. We remain underweight our equity benchmark and retain our underweight in US equities across all portfolios and remain alert to opportunities where we feel the potential return justifies adding risk. 

In May we made some changes to the fund mix, taking profits in one fund that had a lot of exposure to the chip and memory stocks and recycling the capital into other funds with a better valuation and quality profile. Despite our cautious positioning we are pleased to note that the portfolios have kept up with markets without having to run at the front of the herd. 

Finally, we must mention the passing of Alan Greenspan, the second longest-serving Chair of the Fed (1987 to 2006). Whilst some critics will lay the blame for the 2008 Global Financial Crisis at his door (we would largely disagree) his tenure was one of the most effective of any Fed Chair, but he will be mainly remembered for coining the phrase “Irrational exuberance”. Greenspan was early but, in the end, he was proved right. We are reminded of the saying “history does not repeat itself, but it does rhyme”. 

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