Divided

We estimate a 90% chance that the US midterms in November will result in a divided government, with Democrats controlling at least one chamber of Congress. But politics is not the only source of division. Investors are increasingly split over three questions: whether strong earnings growth can continue, where bond yields go next, and how geopolitical tensions will affect energy prices and markets.

On earnings, we remain constructive. We expect third-quarter S&P 500 earnings per share to grow 28% y/y. Yet with semiconductor profits contributing around half of that, management commentary on AI adoption and monetization will be crucial to determine whether the exceptional pace of AI investment can continue. We favor a diversified mix of structural and cyclical opportunities and reducing concentrations in single-stock positions.

On yields, investors are divided between concern about renewed inflation and hopes that tighter policy will ultimately contain price pressures. In our base case, we expect yields to decline over the next 12 months. Following the recent repricing, we believe high-quality bonds offer sufficient income to cushion against a further rise in yields. We favor medium- and longer-duration bonds but remain cautious on the longest maturities given fiscal concerns and elevated issuance.

On geopolitics, renewed disruption to energy flows has intensified concerns over oil prices and inflation. While a prolonged supply shock would present downside risks, we do not think the geopolitical developments alone justify a more defensive investment stance. Broad commodity exposure can help diversify portfolios and provide protection against further disruption.

The US political divide may attract attention in the coming weeks, but questions over earnings, AI, and interest rates are likely to matter more for portfolios. In this letter, we examine those key questions and set out how investors can navigate them.