Video Q3 Market outlook webinar - A shifting playing field

(0:00) For those who don’t know me, I’m Dan Matthews, Head of Portfolio Management here at Aegon. I’ll be joined later by Daniel Douglas Wright, one of the investment managers on our team. He’s also controlling the slides, so I’ll ask him for the next slide, please.

This webinar qualifies for CPD, and we’ll put a certificate in the chat towards the end of today’s session.

With that in mind, these are the learning objectives. By the end of the session, you should be able to describe the key market themes over the last quarter, analyse the changing economic backdrop, and explain the Aegon Portfolio Management Team’s views and convictions across different asset classes.

(0:47) To get to those learning objectives, we’ll start with the team’s investment philosophy, then discuss market themes and the economic backdrop. Finally, we’ll finish with market performance and our team’s views.

We will also take questions. There’s a chat function where you can submit them, and we’ll address those at the end.

(01:08) We start, as ever, with our investment philosophy. This is one of the most important things for our team. We want to view everything through a consistent lens and ensure that our decision-making process is repeatable.

This philosophy flows through our entire investment process. Anything our team touches interacts with it in some way. What does that look like? We focus on longer-term views for our portfolios. We believe starting valuations should matter when making an initial purchase for an asset class. And, unsurprisingly, we believe asset allocation is an important driver of portfolio returns, which is why we do what we do.

(01:45) Let’s turn to the market themes, which will form the bulk of today’s presentation. The first theme is one we talked about at the start of the year and which continues to run on: we find ourselves in what we’ve described as a multipolar world. By that, we mean a world where inflation, growth and policy pressures are no longer moving in the same direction everywhere. Central banks may therefore need to respond differently in one region compared with another.

Secondly, the UK treated itself to a brand-new Prime Minister only yesterday. We’ll look at UK political uncertainty and what that means for both markets and our portfolios. 

(02:23) Finally, the one topic were all tired of hearing about, but we will touch briefly touch on AI. In recent weeks, the markets have reached a degree of AI fatigue, it remains one of the most important and dominant themes across markets.

(02:45) Let’s start with the idea of a multipolar world and policy divergence. We all know what happened following COVID and the significant spike in inflation globally, which we can see on the chart on the left. Since then, it has been a bumpy ride in terms of getting inflation back down.

Looking at the chart on the left, we can see the UK in green and the US in purple. After the initial spike, inflation came down fairly quickly. But since then, it has stubbornly refused to fall below 2%. In fact, many of us are probably getting used to inflation starting with a three and beginning to think that might be the new normal. It is important to remember, however, that the world’s central banking community is tasked with getting inflation down to 2%, not 3%. At some point, central banking dinner parties become rather awkward when they have to continue explaining why they seemingly cannot do their jobs.

(03:39) With that in mind, if we look at the chart on the right, we can see interest rates over time. In response to the inflationary spike in 2022, interest rates rose. As we then moved through a wave of disinflation, rates came down to just below 4%. Until recently, the rhetoric was that this path would continue.

We have also had a new Fed chair in the process of being appointed, who made a great deal of noise about future interest rate cuts. Since that narrative emerged, however, the world has faced a few curveballs: the AI industry has generated a huge wave of new spending, there have been tax cuts in the US, and, of course, there has been conflict in the Middle East.

These two lines represent two very different economies on both charts. The UK, which we’ll touch on later, has just replaced its Prime Minister. It is struggling to control government bond yields, which likely places a lid on spending. It also faces a slightly weaker labour market and a weaker economic growth backdrop than the US. All of this might suggest that inflation should struggle to reignite. However, the UK is also more exposed to energy flows from the Middle East, so those pressures are currently meaningful, and we will monitor how they evolve.

(04:52) The US, by contrast, is growing reasonably well. There is potentially huge AI-related spending. The US government deficit is running at near-record levels. Employment is relatively stable, with a reduced labour force due to migration impacts. While the US faces the same direct impact from Iran, that impact is perhaps marginally smaller. Of course, it cannot hide from global commodity prices, even if it is less exposed to the price of natural gas. So, while these two lines look similar on the chart, believing they should continue to move in the same way in future seems peculiar, given their different backdrops. A central banker in the UK faces an economy that looks somewhat weak and may benefit from stimulus, whereas a central banker in the US sees an economy that is doing reasonably well and could overheat if AI continues to dominate.

In portfolio terms, this means we should be careful about treating duration exposure in the UK and the US as interchangeable. Our funds have, for some time, been positioned on the basis that the dynamics in gilt markets in the UK should diverge from those in Treasury markets in the US, given their different economic backdrops.

(06:16) This slide looks at year-on-year GDP growth. The blue bars represent the US, which is consistently running ahead in the 2% to 4% range. US growth is therefore fairly healthy, whereas UK growth is much more muted, albeit still positive. It is worth saying that, although there are economic risks out there, and we will talk a lot about risk today, none of this data yet suggests that a significant growth slowdown is coming in the near future.

This next slide puts that in context and shows that markets are starting to react differently to those economic backdrops, as well as to events in the Middle East, which are affecting inflation globally.

Here we are looking at market expectations for the number of future interest rate hikes, derived from market pricing. This means it is a probability-weighted figure rather than a literal forecast.

(07:17) For example, the first green bar says 0.4. That does not mean the Bank of England is expected to raise interest rates by 40% of a hike. It means the market is assigning some probability to there being one hike, typically 0.25%, and some probability to there being no hike. That gives an average expectation of 0.4 hikes. The way to read this chart is that once the probability rises above one, the market is effectively saying it expects, on average, one full hike. If it rises above two, it expects two full hikes, and so on.

The green bars show the expected future interest rate path as of March 2026. We can see the market was anticipating that by June of this year, there would have been one interest rate hike, and by September, two. For context, this was just after the Iran conflict broke out, so there was some inflation repricing following the spike in energy costs. The purple bars show June 2026. We can see those initial hikes have been removed from market pricing, and the expectation is now for one hike in November 2026.

(08:29) This is the same analysis, but for the US. Again, green is March and purple is June. Here, market pricing has followed the opposite path to the UK. In March 2026, the market was initially pricing interest rates as being on hold, with the green bars at or close to zero. Looking at the purple bars for June, we can see the US is now pricing in a hike around October to December.

This contrasts with what happened in the UK on the previous slide. Expectations for interest rates in the UK have reduced, while expectations for interest rates in the US have increased. It is worth noting that there is a bit of “chart crime” here: the two axes on these charts are different. While it looks as though there have been different moves, what has actually happened is that the two rate paths have come closer together recently. Both markets are now reflecting a period of interest rates being on hold before a potential hike later in the year, which seems reasonable when we consider the 2% inflation target.

We still need inflation to move back towards 2%. However, I would continue to highlight that the economic growth paths for the UK and US are different. Once the singular pressure from Iran has eased, we may see further divergence.

(09:52) We cannot talk about inflation without talking about the price of oil. We are anticipating policy divergence because of different economic backdrops across the world. But for as long as the Iran conflict remains, there is one influencing factor likely to push markets to behave in a more synchronised way until it resolves: the price of energy. We have represented that here through oil, but it also includes natural gas and other energy derivatives that are putting pressure on inflation globally.

As we speak today, the conflict has reignited. The US has engaged in military operations over the last 10 days, and peace talks appear to have fallen through. The market remains surprisingly calm about this. Yields are elevated and are pricing in some energy distress, but they are not pricing in further disruption to the flow of oil beyond what we saw earlier in the conflict.

We have spoken about Iran at length in other presentations, and in the interests of time, we will not rehash all of that today, other than to say that we are comfortable with the positions we hold and with how they sit within the current political backdrop.

(10:56) If we take a step back from the Iran war, it is fair to say that geopolitical instability has become a significant feature of the investment landscape over the last few years. The chart on this slide is a geopolitical risk index. It is a news-based measure of geopolitical tension. In simple terms, it tracks how often major newspapers refer to things such as wars, terrorism and international crises, events that create geopolitical tension, and turns that into a single line indicating overall geopolitical stress.

The higher the line, the more geopolitical risk is appearing in the news. The lower the line, the less prominent it is. This means the index is a proxy for political risk, rather than a direct measure of events on the ground. It captures coverage of events, not their frequency or severity. Nonetheless, it gives us a useful indication of how much geopolitical risk may be feeding through into market rates.

Geopolitics was one of the themes we identified at the start of the year for 2026, and it is fair to say it has not disappointed. One of the threads running through all the themes we are looking at today, whether AI, policy divergence or a change in UK Prime Minister, is the sense that investors are having to deal with a faster pace of change. To use a familiar phrase, change is the only constant. At the moment, that pace of change is showing very little sign of slowing.

(12:28) That brings me back to the investment philosophy slide we started with: our medium-term view and focus on valuations. Our aim as portfolio managers is to find a path through the noise that leads to good long-term outcomes for clients. In a constantly changing environment, our job is to identify patterns we believe will persist through periods of volatility.

Policy divergence is a good example. Politics and Iran are both having significant impacts on global government bond yields right now. But ultimately, both of those things will change in the coming months in ways we may not be able to predict. What matters is the lasting impact they leave behind — and the lasting inflation trends that may, or may not, emerge from those impacts. In the medium term, we expect divergence to take hold once again.

(12:21) Continuing with geopolitical instability, I’ll start our second theme before handing over to the other Dan on the team to discuss its market implications. I am, of course, talking about the UK political climate and the challenges we face in retaining any sort of leadership for more than five minutes in this country. Yesterday, Keir Starmer stepped down as Prime Minister and was replaced by Andy Burnham. Andy immediately adopted his familiar northern style and gave a speech outside Number 10 without the lectern.

We do not yet know what his full agenda will be. We are getting piecemeal updates in the news as we speak. But it is reasonable to assume that his agenda sits to the left of the current Labour agenda, and we have seen some market reaction in that direction over recent days and weeks, on the assumption that spending is likely to increase.

(14:13) Looking at the slide, we have a couple of charts demonstrating the level of political instability in the UK. On the right-hand side, we show the tenure of post-war prime ministers. As we can see, apart from a couple of longer bars for Blair and Thatcher, UK prime ministers have, on average, had relatively short tenures. Even in that context, however, the tenure of prime ministers over the most recent decade has been incredibly short.

Liz Truss is the barely visible bar, setting a possibly unbeatable precedent — although we shall see.

In short, the UK has now had seven leaders since 2016, six in the last decade, because one left slightly earlier in July and just misses the decade cut-off, and nine different chancellors. That represents a great deal of political change.

(15:04) Depending on your political leaning, it is easy to blame this list of successive failures on “the other side”. But the reality is that the UK has struggled to generate above-trend growth since 2008, partly because of the economy’s reliance on financial services to generate GDP up to that point, and the fact that 2008 was a financial-led crisis.

The practical reality is that, while we have once again changed Prime Minister, we have not changed the economy. The economy is still very much the way it was yesterday. Therefore, the constraints on Mr Burnham are likely to remain very similar to those faced by his predecessors.

The best-known of those constraints is, of course, the country’s ability to borrow. Despite the rhetoric of change that Andy is bringing, it was noticeable that he went to some trouble yesterday to include the phrase “fiscal rules” in his speech.

We do expect him to try to flex those rules, and we will learn how that plays out in the coming weeks. But if he flexes them too much, he will soon discover where the constraints lie.

With that, I’ll hand over to Dan, who will look at market reactions in the UK and then the AI phenomenon.

(16:21) You touched on what political uncertainty in the UK is doing to markets, and we’ll start with government bonds. We can see the impact of this uncertainty when we look at bond yields. A yield is simply the compensation an investor would demand for lending to a government. Post-pandemic, government bond yields across the developed world have gradually moved higher, driven by renewed inflationary pressures, persistent fiscal deficits requiring increased issuance, and the scaling back of quantitative easing, or QE, which saw central banks buying government bonds.

(17:00) When you add all of this together, yields are now at levels not seen in the last 20 years. However, there is one notable feature shown on this chart: UK government bond yields are an outlier, trading above many of their developed market peers. These peers are represented by the blue shaded area, which is a composite of government bonds issued by countries such as the US, Germany, Japan and France, among others.

(17:30) It is not only in bond markets where UK assets are trading cheaply relative to peers. We see this in equity markets too, arguably at an even more extreme level. A lot has happened over the last decade. If we go back to 2016, UK equities traded broadly in line with both European and global equities on a valuation basis. But over the following decade, we have seen a steady de-rating. While there has been a modest recovery in recent years, UK equities still trade at a meaningful discount.

Part of this reflects the fact that the UK is not home to large-cap technology companies, which have been the go-to asset in recent years. The FTSE 100, made up of the 100 largest publicly listed companies in the UK, is certainly more international than domestic, generating over 75% of its revenue from overseas. But I would describe it as an old economy rather than a digital economy.

(18:37) When you buy the FTSE 100, or UK equities more broadly, you are not buying technology companies. You are buying meaningful exposure to sectors such as banks, energy and consumer staples.

So the question this poses to Dan, myself and the wider team is whether this discount is justified.

Looking ahead, in a world of greater geopolitical uncertainty, rising demand for finance for real tangible assets, and growing investment in energy infrastructure and data centres, these sectors could become a tailwind for UK equities. We could start to see that discount narrow.

(19:20) Turning to one of the defining themes not just of the quarter, but of the past few years: the AI capex cycle. It is difficult to overstate the scale of investment as companies race to secure computing power, data infrastructure and a competitive edge in the AI world. On the left, you can see how AI capex, in other words, how much US companies are spending in pursuit of AI supremacy, has evolved since 2023. The numbers are remarkable. Over the past three to four years, spending has quadrupled, with companies expected to invest close to $800 billion this year.

I am conscious that when people talk about hundreds of billions, numbers with several zeros can easily become lost in translation. So if there is one thing to remember from this slide, it is this: the entirety of the publicly listed mid-cap space in the UK, known as the FTSE 250, has a market capitalisation of roughly $400 billion.

(20:32) If you took every company in the UK mid-cap space and added up their total value, the sum would be around $400 billion. So with the amount being spent on AI this year alone, you could buy all of those companies twice over. This highlights two important points. First, the valuation gap in UK equities. Second, the level of exuberance currently present in the AI space. What we are beginning to see is that this surge in AI spending has disproportionately benefited equity markets with significant technology exposure.

I share the chart on the right because, at face value, one might think that owning US equities and Korean equities would provide diversification. Regionally, that would be correct: the US is very different from Korea. However, when we look at the composition of each market, we see a lot of commonality.

The US is well known as the “mega-tech capital” of the world and is home to household names such as Nvidia and Microsoft. Around 35% of US equities are invested in technology companies.

(21:48) But look at the column on the far right, which shows exposure to technology companies in Korea. Over 60% of Korean equities are in technology companies. What this chart does not show is the degree of stock or company concentration. Within that 63% allocation, the vast majority is made up of just two companies: Samsung and SK Hynix.

Knowing how a market is constructed, understanding what you are buying, and understanding the exposure you get when you invest is becoming increasingly important, especially as the AI debate becomes more nuanced. We are seeing investors become more discerning about who the long-term winners in the AI space will be.

(22:42) If we focus first on the light blue line, this shows the return of US equities, represented by the S&P 500, year to date up to 7 July. The broader US equity market returned just over 9%, which is respectable when you consider that the long-term annual equity return is around 6% to 7%.

We then show the pinkish-purple line, which is an index of AI winners, companies that are beneficiaries of the AI world and increasing AI capex spend. Dan made the point earlier that these companies have come under pressure since mid-June, but they have still comfortably outperformed the broader US market year to date.

The key point of this chart, however, is shown by the two lines on either side: semiconductors and hyperscalers. Both are part of the AI ecosystem, but they have experienced very different fortunes. Semiconductors have returned nearly 70% year to date, while hyperscalers are flat, if not modestly negative. The reason for this divergence is straightforward. Hyperscalers are the companies spending the $800 billion in investment, while semiconductor companies are the ones receiving it.

(24:10) Markets are increasingly beginning to question whether this enormous investment can ultimately be monetised. Dan and I have a view on this, but I suspect the market will continue debating it for some time. For those joining next quarter’s update, it is highly likely we will revisit this theme.

Focusing on Q2, I appreciate this may already feel like a long time ago. A lot has happened in the last 21 days, and perhaps we can discuss July in the Q&A. But looking specifically at last quarter, it was a relatively positive backdrop for equity markets.

We saw an easing in geopolitical tensions, with expectations of a ceasefire between the US and Iran. This improvement in risk sentiment benefited equities, risk assets, and countries viewed as key AI beneficiaries. We can see this on the chart on the right-hand side. Emerging market equities led the way, returning over 21%. Emerging markets include countries such as Taiwan and Korea. We have already discussed the concentration of technology and AI-related companies in Korea, and it is a very similar theme in Taiwan, particularly with TSMC. Emerging markets therefore led the way, followed closely by US equities.

(25:39) For bonds, it was a more challenging backdrop, and returns were mixed. However, we did see a bright spot, with UK government bonds outperforming as expectations of further rate hikes were scaled back. This reflected a slowing economy, as well as expectations that inflationary pressures would ease as the oil price experienced one of its most material quarterly declines. As you can see on the far right, the oil price fell by over 30%.

The only other asset that was negative over the quarter was gold, the traditional safe-haven asset. As investors favoured risk assets, they moved away from more defensively positioned assets such as gold.

(26:31) Turning to current positioning, our valuation framework will always lead us to temper our exposure to the more expensive parts of the market and avoid areas where enthusiasm has overtaken fundamentals. In practice, this means we favour equity markets such as the UK and Japan, where we are currently overweight.

We have discussed the relative cheapness of the UK market, and we think it is well positioned if some of the enthusiasm around AI begins to fade, given its limited exposure to the theme and its more defensive characteristics.

In Japan, despite recent performance, valuations remain attractive both relative to other developed markets and to Japan’s own history. However, it is important to say that, as with the UK, valuation alone is not enough. Sometimes something is cheap for very good reasons. We are looking for parts of the market that are attractively valued, but where there is also a catalyst that can unlock value and lead to a re-rating.

(27:41) Japan is a useful case study. We are seeing ongoing corporate reforms under Prime Minister Takeichi gather momentum, driving better capital allocation decisions and improving return on equity, which should ultimately benefit shareholders.

Of course, you cannot be overweight without being underweight somewhere else. One area where we are currently underweight in portfolios is the US.

Some of you will be familiar with the rationale: valuations are close to historical highs, and as investors become more selective around AI, the risk of a pullback has increased.

(28:24) Finally, when we look at bonds, we remain constructive on UK government bonds. Investors seem to have priced in what could happen rather than what is currently happening. They are pricing in a Burnham government associated with fiscal largesse, in other words, spending more money than is coming in. This is certainly a risk factor.

However, if we see a degree of fiscal prudence, whether because the market prevents additional spending, or because it happens voluntarily, and, let’s not say it too loudly, if we see positive growth in the UK, these could be strong catalysts for a repricing in UK gilts, given how they trade relative to peers.

In corporate bonds, we are overweight. Our view is that the likelihood of recession remains low. However, the compensation we are currently getting for investing with corporate issuers, the spread, or compensation for lending money to a company, is towards historical lows, so we remain underweight there.

(29:35) That was a lot of information, so to conclude: global markets remain in a fragile equilibrium.

Earnings growth is still robust at the headline level, but it is increasingly concentrated in a narrow part of the market, namely technology and AI-related companies. As a result, market leadership has become highly concentrated, and valuations in some areas may leave investors developing something close to altitude sickness, given how elevated they have become.

Against this backdrop, we continue to favour a valuation-driven approach. We remain underweight the more expensive regions while seeking opportunities in markets where valuations are more attractive and fundamentals are improving, in other words, where there is a catalyst. Most importantly, our focus remains on diversification and active portfolio management, ensuring that portfolios are not overly reliant on a single theme or outcome.

With that, I will pass back to Dan.

(30:50) .We have had a few questions in the chat, which I will do my best to answer. Feel free to add any more while I’m talking, and I’ll do my best to get to those too.

We’ve had a couple of questions that follow a similar theme: there has been quite a lot of perceived change in the portfolio recently, so has there been any change to our process or philosophy as a result?

The first point I would make is that we have actually had the lowest number of changes in these portfolios for quite some time. There has been one change this year, which was to reduce our exposure to government bonds slightly.

It is easy to forget that, before the Iran conflict, gilt yields briefly traded at around 4.2%, whereas today they are closer to 5%. At that point in the year, our gilt position was sitting on a fairly healthy profit, so it made sense to reduce our exposure a little.

(31:46) But if we look at the average number of changes within our portfolios, it is not higher this year than it has been in the past. If anything, it is probably marginally lower. We have chosen not to overly tinker in the face of the geopolitical conflicts that have emerged, and not to react too strongly to short-term market volatility.

Instead, we have tried to stay true to our philosophy. We have taken a step back and asked: where is the value? What is the longer-term view? Has that longer-term view been affected by recent events?

In our case, we have concluded that it has not. We think the most appropriate thing to do is to continue holding most of our positions. We have held our Japan overweight for a very long time, and we have also held our US underweight for a very long time.

(32:36) In the UK, we have made some shifts beneath the surface between market caps, as we have seen different levels of opportunity in valuations. Most of the change has been in bonds, but that is also where most of the volatility has been. It has therefore been appropriate for us to adjust the mix of bonds within the portfolios over the last few months.

In terms of process and philosophy, there has been no change. The philosophy slide is identical to the one we have been showing since I joined Aegon, approximately five years ago, and I believe since the inception of these funds. I do not anticipate any changes to that slide going forward. We continue to approach markets with a valuation-driven mindset. We ask whether a valuation is appropriate and whether there is a way for that valuation to become unlocked. I would describe the philosophy as valuations in their macro context, and that remains unchanged.

(33:26) That said, we do improve our investment process. If we have access to a better valuation model, or a model that gives us a different perspective on valuations, we will use it. We are not going to say, “This is our valuation model and we will never change it.” Similarly, if we can access better macro research or better macro data, we will use it. What we will not do is disregard valuations, and we will not drift away from our starting philosophy.

We are conscious that our clients do not typically hold just one fund. They usually hold many funds, and it is our role to sit alongside those funds and behave in the way clients expect us to behave. We take that role very seriously, and we will continue to do so.

(34:04) Another question we have had is whether we have the ability to invest in AI winners and avoid AI losers.

That is an interesting question, because it assumes we know which companies will be winners and which will be losers, and at this point, that remains very much an open question. The answer is that these funds hold broad indices. At the stock level, we do not invest directly, so we do not buy AI baskets or traditional baskets. However, if you think back to the slide Dan showed, highlighting the weighting of technology within different markets, we absolutely can factor that into our investment view.

(34:37) We can tilt towards markets with less AI exposure, or towards those with more or less technology exposure, or more or less traditional value-driven market exposure. Where our funds hold active funds, we can also tilt slightly towards value or growth in that regard.

So we do think carefully about which parts of the world may benefit from AI as a theme. But we are not stock pickers, and we are not trying to be. We are trying to assess macroeconomic cycles and identify where it is attractive to invest over the medium to long term, rather than deciding that a specific company will benefit from a particular type of AI. That is not the style or philosophy of these portfolios.

(35:16) One more question we have had is whether Andy Burnham will be a short line or a long line on the chart we showed.

That is an interesting question. I think the answer depends on what he does. It is very hard for him to pursue a radical agenda without a mandate, and at the moment he does not really have one.

The early signs suggest he may go to the country sooner rather than later to try to secure that mandate. He has promised a 10-year plan later this year, and we have already started to hear murmurs about defence spending going up, personal allowances increasing, and, this morning, potential cuts to hospitality business rates.

The reality is that those commitments add up to numbers he cannot currently deliver under the existing fiscal rules. He has also committed to not changing those fiscal rules. That means he is either going to disappoint his party by overpromising and underdelivering, which is the one thing politicians are taught not to do, or he is going to have to seek a mandate at some point.

For the time being, it remains to be seen. I think the country will decide how long that line is, rather than the bond markets. But if he pushes too hard, and breaches those fiscal rules, I do think the bond markets will push back quite aggressively.

(36:35) I do not think we have any more questions coming in. Apologies if I have missed yours. Please feel free to reach out to us through other communication channels, and we will be very happy to arrange a meeting or answer your questions directly.

That just leaves me to say thank you very much for your time. It is greatly appreciated, and thank you for your support.