Oil prices have not risen further, largely because oil flows of between 5 and 9 million barrels per day were maintained from the Gulf during August, compared with around 20 million before the crisis. This has been achieved through shuttle tankers and a “dark fleet” operating through Hormuz, alongside the Saudi pipeline to the Red Sea. Additional supply from the US, West Africa and Central Asia, together with releases from global strategic reserves, has also helped.

Although these measures have reduced the immediate impact of the oil deficit, higher energy prices have continued to raise inflation expectations, putting upward pressure on interest rates. US long-term borrowing costs recently reached their highest level since 2004, as rising oil prices and resilient economic growth increased expectations that the Fed may raise rates further. The global sell-off in government bonds has also extended to the UK, with the government recently having to sell the 10-year gilt with an average yield of 5.383%, the highest level since 1999. Fixed-income investors are demanding higher yields to compensate for various factors mainly around inflation risks, better nominal growth and government deficit concerns.

Against this backdrop, the strength of global equity markets requires explanation. The primary driver has been the exceptional performance of US earnings. In early April, the S&P 500 staged its fastest recovery on record, recovering its 9.1% decline associated with the Iranian crisis in just eleven trading days as Q1 earnings were reported. The recovery was concentrated particularly in US technology companies and beneficiaries of AI-related capital expenditure.

Expectations for Q2 earnings were already high, but companies again exceeded them, with earnings rising 50.1% compared with Q2 2025. Current expectations are for earnings growth of 23.6% in Q3 and 27% in Q4. Nvidia, the world’s largest company, has been a particular standout, recently reporting expectations for 70% earnings growth in 2027.

Strong earnings growth during the first half of the year has helped ease valuation concerns. The US technology sector is now valued at approximately 23 times earnings, down from 26 times as earnings growth has outpaced share price gains. Concentration remains a concern, with the ten largest S&P 500 companies accounting for approximately 39% of the index. Strong 2026 earnings growth means these companies are trading at valuations closer to the other 490 constituents, rather than at the significant premium that had persisted since 2020. The broadening of earnings growth has also been encouraging, with the median S&P 500 company reporting 14% year-on-year earnings growth in Q2.

European and UK equity markets have not kept pace with the US, but their resilience has nevertheless been notable given their relatively limited technology exposure and the fact that both regions are net oil importers, unlike the US. Performance has been supported by broader earnings growth, particularly in the value-oriented sectors that dominate these markets, including financials, industrials and energy. European equities have also benefited from upward revisions to earnings expectations, with economists having previously been too pessimistic, as well as from record investment flows. The ECB recently raised interest rates by 0.25%, while also increasing the Eurozone growth forecasts for 2026 and 2027.

The Bank of England has been an outlier in not increasing interest rates so far. However, it has recently indicated that it may raise rates this year for the first time in three years unless oil prices fall substantially. Despite this, the FTSE 100 has delivered solid performance and continues to trade at a significant valuation discount to the S&P 500. This valuation gap is reflected in the increased level of corporate activity, with six FTSE 100 companies having been subject to takeover bids so far in 2026.

UK consumer confidence rose again last month, marking the strongest sustained improvement in household optimism for two years. UK productivity has also finally begun to improve following a prolonged period of weakness, confounding some economists. One possible explanation is the growing impact of AI on the services sector, which accounts for more than 80% of the UK economy.

AI has continued to underpin equity markets, particularly in the US and Asia. Anthropic and OpenAI are both taking steps towards public listings, with valuations reportedly expected to reach between $1-$2 trillion. Meanwhile, the US hyperscalers are projected to spend approximately $780 billion on AI-related capital expenditure in 2026. This investment is flowing through an extensive supply chain centred on US and Asian semiconductor companies.

Looking ahead, investors will increasingly focus on whether the productivity gains generated by AI, and ultimately the return on investment and expected earnings, can justify the substantial costs involved in developing foundation models and building the associated data-centre infrastructure.

Fixed income has been disappointing in 2026, failing to provide its usual defensive characteristics during March’s market volatility as inflation concerns pushed bond yields higher. Bonds recovered during Q2 as the initial energy shock subsided but have come under renewed pressure as persistent inflation concerns, higher nominal growth, rate hikes and increased issuance from US hyperscalers have driven global yields higher. With real yields now significantly more attractive than in recent years, fixed income once again offers investors the potential for attractive returns and provides a greater margin of safety than was available when yields were close to historic lows.

Gold reached an all-time high in January but has subsequently declined significantly, primarily due to rising US Treasury yields, a stronger US dollar and more hawkish Fed rate expectations. Nevertheless, the fundamental arguments supporting gold remain, particularly continued central bank purchases and as a potential hedge against fiscal sustainability concerns, currency devaluation and geopolitical risk.

Q3 was characterised by continued geopolitical tensions surrounding the Iranian crisis, resulting in significant macroeconomic volatility. Inflation concerns pushed bond yields higher and prompted some central banks to increase interest rates. As in April, when the Q1 earnings season provided strong support for equities, exceptional Q2 earnings have helped equity markets. Given the strength of earnings momentum, equity markets might otherwise have delivered even stronger returns, but this challenging macroeconomic backdrop, renewed pressure on oil prices and higher bond yields have dampened performance.

Q4 is likely to remain focused on the secondary economic and market effects of the Iranian crisis. With the economic costs of the conflict becoming increasingly significant, there may be greater incentives on both sides to seek a negotiated settlement. A resolution to the crisis, combined with Q3 earnings meeting or exceeding expectations, would provide a supportive backdrop for markets into year-end. However, geopolitical and inflation risks remain difficult to predict. We also remain watchful on the outcome of the US mid-terms and the UK budget. As recent years have demonstrated, maintaining diversified portfolio exposure remains important in navigating an uncertain investment environment.

Please note that the value of investments and the income derived from them may fluctuate from time to time.