1.1 Strong Earnings Season Overshadowed by the Gulf Conflict, the New Fed and AI Fatigue

In a July of tragic wildfires, financial market participants too faced risks amid highly volatile markets. Markets were shaken above all by: the rekindling of the conflict in the Gulf; the unconventional start by the new chairman of the U.S. Federal Reserve (Fed); and finally by the continuing questioning of the prevailing AI narrative -- "more is more" – that is used to justify huge volumes of AI spending.

The Gulf conflict led unsurprisingly to another rise in oil prices, with Brent crude climbing from just above U.S. dollar (USD) 70 per barrel at the beginning of the month to more than USD 100 at its peak. This, in turn, affected bond yields, which also had to contend with a memorable press conference by new Fed Chair Kevin Warsh, following the Fed’s July meeting. In it Warsh emphasised how little he thought of short-term fine-tuning of market expectations. Instead, he wanted to leave it to markets to form their own independent view of the economic environment, rather than anticipating Fed reactions. Whether this experiment succeeds in the long run remains to be seen. In the short term it unsettled the market, provoking the highest 30-year U.S. Treasury yield since 2007, at 5.27%, and the highest 10-year German Bund yield since 2011, at 3.20%. That said, these rises cannot be attributed to Warsh alone. There is justifiable concern that government spending is pushing debt levels and long-term yields higher. And another macro driver may be at play: the economy is performing better than expected. This was evident in numerous macroeconomic data releases, resulting in sharply rising surprise indicators in what has so far been a very solid earnings season.

High Expectations Surrounding Technology Stocks Fuelled Sharp Market Swings

Just a few months ago, few market participants would have expected companies to navigate the war-stricken second quarter so successfully. More than half of index constituents have now reported their results and S&P 500 companies are showing revenue growth of 15% year-on-year and Stoxx Europe 600 companies 9% year-on-year, while their earnings growth is significantly higher but distorted by many one-off factors. The European market in particular has welcomed this, with the DAX reaching a new high at the beginning of August. In the U.S. it was the Equal-Weight S&P 500 index that reached a new record.

Behind this lies sector rotation in the second quarter. While the heavyweight stocks, particularly in the technology sector, were hit quite hard in some cases, value stocks and/or defensive sectors proved considerably more resilient. Technology stocks once again delivered very strong quarterly results yet concerns emerged in the market regarding the AI complex: would the industry's staggeringly high levels of investment really pay off one day? Would lower-cost Chinese models continue to gain market share? And might policymakers eventually take a stricter approach to the sector?

The market nervousness was trumpeted by a battering of the previously surging semiconductor sector (Philadelphia Semiconductor Index, SOX), which recorded a 21% decline in July. South Korea's KOSPI lost as much as 22% and featured nine trading days on which moves exceeded 5% in either direction, including one decline of 11% and one gain of 18%.

As unusual as the developments in the SOX and KOSPI were, what was truly remarkable in July was the high volatility of individual stocks. Within the overall rather unremarkable S&P 500 (the VIX volatility index showed no signs of panic and remained below 20 points), even mega-cap companies with trillion-dollar market capitalisations repeatedly recorded double-digit percentage share-price moves in a single day. And Microsoft's USD 450 billion increase in market value in a single day set a new global record.

One reason for this may also be the degree of leverage in the market. A notable example was Leopold Aschenbrenner's U.S. fund, Situational Awareness, which ran into difficulties in July due to its heavy use of borrowed capital. It was forced into fire sales. Deutsche Bank notes that 3% of South Korea's adult population received a margin call from their broker over the past few weeks. That is certainly food for thought, suggesting a bubble mentality may have taken hold. Investors around the world have many reasons to watch the new Fed under Kevin Warsh closely.

July’s news flow was certainly more than trading desks half emptied by the holiday season could fully digest. And so we expect it is now likely that markets will need some more time to decide whether the correction in some tech names has cleared the air sufficiently – or whether the AI-story has suffered a lasting blow. Also unresolved and on investors’ minds is the war in the Gulf, with its capacity to push up oil prices and inflation. And yet the biggest headache for investors, we believe, is learning how to read the new Fed chairman. Kevin Warsh does not want to provide any guidance and the obvious risk is that markets might doubt the resolve with which the Fed is fighting inflation risks. The still bigger risk may be that markets will question the Fed’s willingness to flood the market with liquidity should things turn sour. Is the so-called Fed put at an end?

2.1 Fixed Income

For the time being we are not changing our views on government bonds. Our view remains that the shorter end especially of the curves in Europe and the U.S. remain attractive as we believe markets are pricing in too many rate hikes by central banks, particularly in the U.S. But we do expect further volatility. The markets may test the Fed’s credibility and Warsh’s policy of avoiding giving markets any guidance.  

The one change we made in the fixed income space in July was to downgrade Euro High Yield Corporate Bonds to minus 1. With the re-escalation of the conflict in the Gulf, geopolitical risks have materially increased. This is evident in soaring energy prices and rising government bond yields. Both of these developments should have a negative impact on the high yield market, especially as this segment is more prone to idiosyncratic risks related to external shocks than the Investment Grade market. Euro HY spreads have remained very tight in recent months and don’t, in our view, reflect the short-term risks adequately anymore.

2.2 Equities

It is still all about technology on equity markets. Before, this sector was lifting the entire market. But in the past weeks it has fallen yet overall markets are still holding up quite well. We had become cautious because of the high valuations in the semiconductor space earlier in the summer but we are now taking the opportunity to upgrade the segment again.

Our reasoning is that over the past month we have seen a harsh but healthy share price correction in technology, especially in semiconductors. The earnings stream of memory semiconductors will remain cyclical and current memory chip net margins of 60% are clearly not sustainable for multiple years. But, as the memory chip supply is growing only gradually while demand remains strong, a shortage is likely to persist for several more quarters. Moreover, some semi shares have collapsed by 60%, their losses amplified by leveraged sellers who were forced to sell, and we believe this has resulted in an overreaction. We are also upgrading the global software & services sector to neutral from underweight. Since September 2025 the price/earnings ratio (P/E ratio)^[1] for the Software and Services sector has declined from 28x to 18x. But not all software companies have suffered in the IT correction, and therefore careful stock picking remains mandatory in this segment.

With the outlook for two of its three subsegments having improved, we are upgrading the entire IT sector, following a 6 point decline year-to-date of its P/E ratio. A P/E ratio of 14 is, we believe, too cheap when earnings per share (EPS) growth is forecast at 24%. The IT sector stands out among the 11 MSCI sectors as the one with the lowest P/E to growth ratio,^[2] at 0.7.

We do not believe the AI boom is over. We are still in the early stages of this technological revolution. The data center build-out will continue rapidly and the “silicon-intensity” of the economy will continue to rise at unprecedented speed. But hyperscalers are aware that shareholders want more free cash flow or some further proof that they are monetizing AI successfully. There has been reassurance from some, but not all hyperscalers in the reporting season. More capex discipline and a focus on free cash flow could support rising multiples in their shares.

Some yellow flags remain. 1) Data center capital expenditures (capex) could peak in 2027 or 2028 as rising bond yields and rapidly expanding credit default swaps (CDS) spreads on neoclouds are a clear indicator that there are financing limits on the giga-projects. The circular and vendor financing deals of some of the bigger players are not reassuring either. 2) Meanwhile China continues to surprise on the upside with its extremely efficient large language models and progress in semiconductor manufacturing. 3) The U.S. mid-term elections are approaching, and some Democrats might choose to campaign with an anti-AI, anti-new data center agenda. 4) The delay in OpenAI’s initial public offering (IPO) until 2027 is a clear negative, indicating that a key industry player is struggling to achieve new innovative progress, at least for the time being.

2.3 Alternatives

Gold

We expect the gold price to remain range-bound in the short term, as has been the case in recent weeks. The World Gold Council expects 2026 central bank demand to come in below 2025.  Even so, we expect central banks to continue to purchase more gold for reserve purposes. The trend towards de-dollarization will continue for China and other countries that are seeking to diversify away from the dollar and the use of U.S. currency as a global standard for trade settlement. This should help gold maintain a floor near 4,000 USD/oz, a level that is also somewhat more conducive to jewelry demand in India as well. Conversely, any upside on gold might be capped by the markets’ expectations on real bond yields. Though there were three dissenting Fed member votes in favor of raising rates in July, the market still viewed Chairman Kevin Warsh as too dovish in his post-meeting press conference. Treasury yields sold off, but gains in the gold price swiftly reversed afterwards. Uncertainty about inflation and the Fed's policy path clearly limits how much upside we could see in gold in the short term.

Oil

We upgraded oil from Neutral to +1. The U.S./Iran Memorandum of Understanding in June only brought a short reprieve in the conflict as it was too vaguely formulated and left the door open for disagreement, not least about ownership of the rights to regulate and control shipping traffic. It is not clear what the next steps for the diplomatic process may be, especially since the expansion of the conflict to the Red Sea and the involvement of the Houthis, which has brought Saudi Arabia into the fighting. The Ukraine-Russian conflict is also worsening. Ukraine has expanded its range of targets, from oil transport and refining infrastructure on land to ships in the Black Sea – with a severe economic price for the Russian aggressor. Moscow has announced that it is halting its exports of diesel and gasoline until September 1 and is actively contemplating importing refined products to meet domestic demand as well. These conflicts make us believe that the oil price has room to move up again.