Global equity markets generated some solid results in the second quarter, with unrelenting enthusiasm around the artificial intelligence boom and optimism for a ceasefire between the United States and Iran supporting risk appetite. However, stock markets lost some of their luster in June.

The high-flying technology and megacap space proved to be a source of volatility late in the quarter as traders reassessed the sustainability of the AI trade and related stock valuations. Just as concerns over the oil shock were fading, cost pressures stemming from the AI boom leapt to the forefront, underscoring the sensitivity of equity markets under the influence of lofty valuations, elevated interest rates and market concentration.

In local currency terms, the MSCI All Country World (14.9%) ended the second quarter near record highs. The S&P 500 (15.2%) posted its best quarterly performance since the post-pandemic rebound in 2020, led by outperformance in the heavyweight technology space. The S&P/TSX (7.0%) also advanced but underperformed as weak (negative) performance in the energy and materials sectors outweighed stellar performance in the financials space. The MSCI EAFE also had a decent quarter (10,8%). Finally, the MSCI gauge of emerging market stocks (24.1%) significantly outperformed its developed market peers, powered higher by an impressive rally in Asian chipmaker stocks that drove robust gains in Korea and Taiwan that represent more than 50% of the index.

Investment Strategy

Our high probability scenario calls for an environment of “Sustained Inflation” over the next 12-18 months. While pricing pressures persist and inflation holds firmly above central bank targets, well-anchored inflation expectations allow for a pragmatic (less hawkish) policy response which, in turn, helps to alleviate the potential for severe downside pressure on the economy. Still, with interest rates remaining higher for longer, global growth prospects are likely to shift modestly lower – a dual headwind for both valuations (the “P” in P/E) and earnings expectations (the “E” in P/E) that poses some challenges for stock markets that are trading near record highs.

While much of the good news has been priced in at current levels, equity markets could be vulnerable to a negative surprise. Namely, a prolonged and unsettled conflict in the Middle East, an intensification in the trade war and/or a bust in the AI trade still pose downside risks to the outlook. Barring a profound, investment-led productivity boom that extends the bull market in stocks – which is less likely in our view – we expect equities to remain on the defensive. We maintain an underweight stance on equities over our tactical 12–18-month horizon.