Rising yields | Risk and opportunity

Global activity is holding up, but the environment is becoming more demanding. The war in the Middle East is adding pressure on energy, transport, and supply chain costs. At the same time, US political uncertainty clouds the outlook and heavy government borrowing are contributing to higher long-term bond yields.

Higher bond yields create risks for equity markets that are already expensive, especially in the US, but they have also restored many income benefits (investors are earning higher yields on bonds) and diversification benefits to developed-market bonds. We remain underweight US equities, favour Europe, emerging markets and Japan, and expect some US dollar weakness over the coming 18 months.

Resilient growth meets a tougher inflation backdrop

Global GDP growth remains close to 3%, and recent indicators suggest renewed momentum in the US. Corporate earnings have been even stronger. Yet aggregate profits cannot outpace nominal GDP indefinitely, particularly when US profit margins are already high, public debt is stretched and household saving is low. Much of the exceptional US earnings performance also appears to be reflected in valuations. The war in the Middle East complicates this picture.

If these pressures persist, central banks may need to keep policy restrictive or raise rates further, cooling discretionary spending and lifting the discount rate applied to future earnings.

The US mid-term elections add another layer of uncertainty. A Democratic sweep of the House and Senate has become a more plausible scenario, although the outcome is far from settled. Such a result could constrain President Donald Trump’s legislative agenda and create a more adversarial policy environment. For markets, the central tension is between resilient activity and earnings on one side, and inflation, fiscal risk and demanding valuations on the other.

China: liquidity is not enough

China remains a major risk to the global outlook because domestic demand is weak and private-sector confidence has yet to recover. Credit creation and money-supply growth have been subdued, suggesting that stimulus has not produced a sufficiently strong response from households and businesses. The challenge is therefore not simply to provide more liquidity, but to rebuild confidence and generate sustainable spending and investment.

A prolonged slowdown would affect exporters and commodity producers because China remains central to global industrial demand. Investors should watch credit creation, property activity, consumer demand and money growth for evidence of stabilisation. Until these indicators improve, China is likely to remain a risk to global demand.

Europe could surprise positively

Europe may provide more support to the global economy than recent sentiment implies. Prospective fiscal expansion, particularly in Germany, could sustain regional momentum. Energy costs, geopolitical risk and softer global trade remain constraints, so the case is not for a powerful boom. Rather, steady or moderately improving growth would be a meaningful positive surprise, even as China struggles and tighter financial conditions create risks in the US. Rising rates still pose a risk to Europe, though, as countries such as France grapple with persistent deficits.

A European recovery matters especially for South Africa. Europe is the country’s largest trading partner and a more important export destination than the US. Resilient European demand could support exports, corporate earnings, tax revenue, and the trade balance, partly offsetting weaker domestic growth in China.

Developed-market bonds offer a margin of safety

Developed-market bond yields have risen sharply as inflation, larger fiscal deficits and heavy capital spending increase competition for capital. This has caused volatility and capital losses, but it has also transformed prospective returns. A 10-year US Treasury yield of around 5% provides meaningful income and a cushion against further moderate increases in yields.

We should highlight some risks: inflation could prove persistent, fiscal expansion may continue and AI-related infrastructure investment could keep competition for capital elevated. Even so, bonds once again provide useful diversification. If growth slows, AI investment disappoints or a higher discount rate weighs on equities, falling inflation and yields could produce capital gains for bondholders. Our expectation is for global bonds to return roughly 4% over the coming year. This is less than equities, but with materially lower risk.

Conclusion: Maintaining the risk score

Balancing strong earnings and resilient activity against stretched US valuations, inflation, fiscal uncertainty and higher yields, the GISG kept its risk score at 0 (neutral). Investors can now earn attractive income from high-quality bonds without relying solely on equities. Within equities, we remain underweight the US and overweight Europe, emerging markets and Japan, while expecting a weaker US dollar to support non-US markets over the next 18 months.