At some point in the future, investing in emerging markets will once again become very attractive. At the beginning of the year, major institutions had projected that global multi-asset portfolios would deliver impressive performance this year. However, the subsequent rise of disruptive artificial intelligence (AI) trading, unresolved stresses in the previously troubled private credit market, and the emergence of new geopolitical conflicts have drastically altered the global market environment. Recently, Alexandre Tavazzi, Head of Chief Investment Office and Macro Research at Pictet Wealth Management, shared his insights on investment logic amidst geopolitical conflict, as well as the trajectories of US Treasuries, US stocks, and the US dollar.
Emerging market assets possess strong appeal. Since last year, many analysts have advised global investors to diversify away from US dollar assets into non-US assets. Yet, following the Middle East conflict, the US dollar appears to have re-emerged as a key safe-haven asset. Regarding whether this conflict will renew favor for US assets, Tavazzi stated that clarifying this is crucial for any asset allocation strategy, especially for international investors. He analyzed that while the US dollar has indeed appreciated and served as a safe-haven currency since the conflict began, similar to the Swiss franc, the underlying dollar-denominated assets, such as the S&P 500 index and the US Treasury market, have not been perceived as safe havens. Their performance has closely mirrored assets in other regions, with both US stocks and bonds experiencing declines over a period.
Factors influencing recent trends in US dollar assets include, besides the Middle East conflict, market concerns regarding AI and associated issues with corporate profitability. More importantly, in this environment, US Treasuries have not provided effective protection as they have in the past. Short-term US Treasuries, specifically those with maturities of two years or less, were historically the best safe-haven assets during such geopolitical conflicts. Now, the situation is markedly different. With significantly tighter monetary conditions, the yield on the 2-year US Treasury has surged by nearly 40 basis points. Therefore, the recent strength of the US dollar is more a currency phenomenon and does not relate to the investment value of dollar assets, which have not demonstrated strong risk resilience during this Middle East conflict.
Around the end of last year and the beginning of this year, investing in non-US assets, particularly emerging market assets, was one of the hottest trades on Wall Street. However, following the latest Middle East conflict, emerging market stocks, bonds, and currencies have fallen across the board, raising questions about their long-term appeal. Tavazzi noted that at the start of the year, emerging markets showed potential across equities, bonds, and foreign exchange. He also emphasized that emerging markets are not homogeneous; Asia is a major component of the MSCI Emerging Markets Index, alongside Latin America. Regarding the conflict's impact, he pointed to two main effects: first, the strengthening US dollar has led to depreciation in emerging market currencies, negatively impacting their equities. Second, widespread expectations for interest rate cuts by emerging market central banks, due to falling inflation, have been temporarily put on hold because of the conflict's impact on oil prices and inflation, adversely affecting emerging market assets.
However, from a long-term perspective, Tavazzi expressed that they expect the Middle East situation to improve at some point. Consequently, emerging market assets still possess very interesting characteristics. Central banks in these economies may restart their rate-cutting cycles. Furthermore, observing the emerging market bond market, especially the investment-grade segment, reveals that companies in these economies typically have lower leverage than their US counterparts and offer more attractive spreads, making these investment-grade bonds appealing. Additionally, from the perspective that tangible assets may become more favored, such as critical minerals and metals, many emerging market countries are producers of these specific resources. Therefore, investing in emerging markets will become attractive again at some future point. Long-term, emerging market assets retain significant appeal.
Regarding the prospects for Chinese assets, he highlighted two key points. First, the Chinese market has demonstrated remarkable resilience, which is highly noteworthy. Second, it is essential to distinguish which parts of the Chinese market are growing; impressive changes are occurring in sectors like technology, renewable energy, and AI. Chinese AI companies are being required to open their models for rapid industrial application, representing a truly shining and continuously growing area worthy of attention.
Even before the recent geopolitical conflict, concerns about AI's disruptive impact affected sectors including software, professional services, media, and finance, with some industry stocks experiencing significant declines that dragged down the overall performance of US equities. Some analysts suggest that investors wishing to participate in the AI trade should shift focus from AI enablers to AI beneficiaries. Tavazzi agreed with this prevalent market logic. He noted that while the software industry is indeed being disrupted, not all software companies face equal risk. Large, established software companies integral to daily life face minimal risk due to the irreplaceable nature of their services. However, certain software applications are susceptible to replacement by AI auto-programming, and some companies, especially those unable to provide added value, could face existential challenges. He also highlighted that in the private credit space, loans to software companies constitute roughly 20% of the total, meaning the AI disruption theme also impacts private credit.
On how to approach AI trading and investment, he concurred with the general market view of shifting from investing in AI enablers to AI beneficiaries. Current investment in AI involves massive capital expenditure, with major companies planning over $600 billion in capital spending over the next 12 months, mostly directed towards 'hard' areas like semiconductors and data centers. Data center operations require substantial energy, making any technology that meets their operational and energy needs a worthwhile investment. Companies such as cable providers and power utilities are considered AI trade beneficiaries, as are those involved in areas like 3D printing. AI technology is expected to benefit numerous companies through practical applications, but the direct beneficiaries may not necessarily be the AI companies themselves, but rather producers of heavy machinery, cables, power generation equipment, and semiconductors. More broadly, companies across various sectors stand to gain from AI-driven productivity improvements.
He further emphasized that technology companies, especially AI firms, have been the primary drivers of the US stock market in recent years. Now, as disruptive AI technology becomes more mainstream, the US market is undergoing sector rotation, with the rally broadening to include more stocks. This shift is already observable. Over the past three years (up to 2025), less than 35% of S&P 500 companies outperformed the index, indicating highly concentrated gains in a few names that typically benefited from interest rate fluctuations. Conversely, year-to-date, despite a slight decline in the S&P 500 index, over 60% of its constituents have outperformed the index itself, signaling an expansion of the market rally into other areas. Additionally, the world is transitioning from one prioritizing intangible assets (dominant in AI market trades involving software companies and hyperscale data center operators) to one where tangible assets are becoming increasingly important for both companies and countries.
The recent Middle East conflict has also challenged old investment doctrines. Sectors like consumer staples or healthcare, which typically rise during geopolitical turmoil, have instead fallen. Tavazzi analyzed that as the market began indiscriminate selling due to the conflict, investors also sold off stocks that were still profitable. Thus, not only assets experiencing sharp declines but also previously well-performing stocks were sold, with investors prioritizing asset liquidity. Gold was similarly sold off, while only the Swiss franc and US dollar performed well among currencies. US Treasuries failed to provide their traditional effective protection. Investors realized that increasing cash holdings appeared to be the only option.
US Treasuries, traditionally a safe-haven asset that performed well as recently as February, also defied old doctrines by falling in price and seeing yields rise again after the conflict. Tavazzi attributed the US Treasury market's reaction partly to inflationary impacts from rising oil prices and partly to concerns over US fiscal conditions. Whether past investment experiences remain valid depends on if this situation is different. His judgment is that this Middle East conflict is fundamentally distinct from historical geopolitical conflicts. The direct impact is likely higher inflation. Previously, the 10-year US Treasury yield had fallen slightly below 4%, but markets are now repricing due to oil's inflationary effect. Secondly, market expectations for Federal Reserve rate cuts in 2026 have been significantly scaled back. Long-term, fiscal implications must be considered. Even before the conflict, US fiscal deficits were a market concern; the conflict adds further fiscal cost, evidenced by the Department of Defense seeking an additional $500 billion from Congress to support war costs. Caution is also warranted regarding a US Supreme Court ruling on Trump-era tariffs, which could lead to slightly lower tariff levels. The negative fiscal impact of the Trump administration's proposed legislation might have been partly offset by substantial tariff revenue; any changes to tariff policy could increase US fiscal pressure.
Regarding other fixed-income investments, he stressed that in the current environment, short duration offers clear advantages. The initial consequence of the conflict is inflation, but it could subsequently lead to significant economic slowdown. Rising oil prices represent a supply shock that limits disposable income, ultimately slowing consumption. If this persists, negative economic consequences are likely, though the duration is uncertain. Tavazzi also expressed concern about the US private credit sector. Many private credit funds have halted operations as investors seek redemptions. These funds are a crucial financing source for US small and medium-sized enterprises (SMEs). Combining potential energy supply reductions with financing issues in private credit could, if prolonged, significantly impact US economic growth, potentially forcing the Fed to reconsider rate hikes. Maintaining short bond durations, such as under two years, allows investors to benefit from potential Fed policy adjustments in the coming months. However, he believes the likelihood of private credit deterioration causing systemic risk is low. The exposure of US banks and large financial institutions to the private credit sector, relative to their business and balance sheet size, is not substantial, so it does not currently pose a systemic threat. In contrast, he is more concerned about credit availability for SMEs, as post-2008 regulations have largely excluded them from US bank lending, leaving them reliant on credit markets, leveraged loans, or private funds for financing.
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