Surfing on AI and fiscal dominance momentum - Cross-Asset Views

Since early April, risk assets have delivered one of the wildest rallies of the last decades, leading - both equities and credit - to new price highs, elevated valuations and sending volatilities/implied correlations to very low levels. The “sell/hedge US assets” theme of Q1 is gone (see here) as the fear regarding tariffs has evaporated, and as the AI momentum and US corporate resiliency continue to prove strong. Despite the increase in risk appetite, the gold trade momentum has accelerated and outpaced cryptos as the ultimate debasement trade.So what’s next? Our cross-asset views remain based on three key fundamental themes :-US recession risk will stay low. Today, the macro picture in the US is more difficult to grasp without official data, the job market softens and some cracks appear in the credit market. Tactically, in the short run, we may have some episodes of US recession risk repricing (very low as of today). But 1/ the structural increase of intangible assets in the US economy has reduced cyclicity, 2/ both the Fed put and US loose fiscal policy are powerful bullish forces, that should continue to prevail, as liquidity expands again (the US M2/GDP ratio is up to 84%), see slide 4.-Fiscal dominance will persist. Geopolitical tensions and rising inequalities limit governments' willingness and ability to reduce fiscal deficits, resulting in heightened pressures on central bank independence. This environment should continue to support the equity/gold duo and may also lead to higher inflation B/E, higher term premiums and rates volatility. The theme is not only a US theme (Germany, Japan, UK…), see slide 5.-Corporates will stay resilient, with a demonstrated ability to safeguard margins despite great challenges such as tariffs, macro slowdown and job market supply constraints. The strong start of the Q3 earnings season confirms it. Corporate strength will be further enhanced by fiscal support, ongoing innovation, and significant investments, with AI leading. Hence US corporate margin premium will continue to prevail, see slide 6.In this environment, we maintain our bullish equities vs. bonds outlook, as resilient macro and microeconomic trends, the Fed put, and the AI revolution will continue to feed global optimism. Our expected returns for bonds are capped by our views that curves will steepen further, and that inflation and fiscal risks are skewed to the upside. Finally, despite weak fundamentals, the commodity asset class continues to serve as an effective hedge against the resurgence of inflation and the dollar debasement, which are two key medium-term risks for asset allocation, see slide 9. Several questions remain:-What about equity valuations and investor positioning? High equity valuations represent a significant vulnerability for the market, particularly as rising interest rates should eventually limit PE expansion (see slide 10). However, we believe that earnings growth will continue to provide essential support for equity indices. Additionally, while investor positioning is high, it is not extreme. Although households are significantly exposed (with substantial wealth effects), we estimate that the largest US mutual funds (equity Long Only or Balanced funds) still have room to increase their equity betas. Our most holistic asset allocation proxy shows that equities account now for 53% of non-bank portfolios (vs a post-2008 average of around 48%, and 52% before 2008), but still below 1999 and 2007 peaks.-Are we in an AI bubble? We are not there yet in our view. Although expensive valuations may come under scrutiny, with lingering questions about AI projects and their ROI (see slide 11), the financial strength and monopolistic positions of the U.S. large tech companies, along with political/state support (as technology is increasingly viewed as a geostrategic sector), should provide a buffer against potential shocks.-Is there a dollar risk? We anticipate a weakening of the dollar next year, but expect defiance to remain limited, as reflected by on-going strong foreign inflows into US assets (see slide 12). We believe this relative dollar stability may eventually affect gold prices.-How to address the increasing asymmetry of safe haven assets? Alternative strategies will be key, for hedging purposes (use defensive strategies to hedge short-term corrections or CTAs for their long-term convexity) or for risk-on diversification (using emerging or commodity strategies). See slide 8.