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Over the past few days, we have been putting together the presentation for our Investment Committee meeting next week. As part of that process, we have been reviewing the developments driving markets and considering what they may mean for the positioning of our clients’ portfolios. 

A few things have caught my eye… 

Markets have had a tougher week as investors reassessed how quickly inflation will fall and whether interest rates may need to remain higher for longer. At the same time, there have been some encouraging signs from economic activity, China and global technology investment that should not be overlooked. 

The latest US economic readings show that activity remains reasonably solid. According to the Institute for Supply Management, the US Manufacturing Purchasing Managers’ Index, commonly called the PMI, was 54.6, while the Services PMI was 55.4.  These monthly surveys ask business managers about new orders, production, employment and costs. A reading above 50 generally indicates that activity is expanding, so both parts of the US economy are still growing. 

The US Bureau of Labor Statistics also reported that employment rose by 162,000 in August, while unemployment remained at 4.1%. This is encouraging, but resilient economic activity makes it harder for central banks to reduce interest rates when inflation remains elevated.

Inflation remains the immediate concern

The US Bureau of Labor Statistics reported that producer prices, which measure many of the costs faced by businesses, rose by 5.4% over the past year. Energy was a major contributor, but higher costs are also appearing in freight, transport and other business inputs. 

We will therefore be watching tonight’s US Consumer Price Index closely. This will provide a better indication of how much of these higher costs is reaching households and may influence the US Federal Reserve’s interest-rate decision next week.

The European Central Bank has already responded by raising interest rates by 0.25% this week. Bond markets are now allowing for the possibility that other central banks may also need to keep rates higher or raise them again.

This has pushed up the returns available on government bonds that mature in 10 years or more. When market interest rates rise, the value of existing fixed-rate bonds falls. Higher long-term interest rates also place pressure on shares, particularly highly valued growth companies, property and infrastructure investments whose valuations rely heavily on profits expected many years into the future.

Fuel security and geopolitics

Fuel security is about more than how much oil the world produces. It also depends on whether fuel can be transported, refined and delivered safely and at a reasonable cost.

The conflict involving Iran has already disrupted shipping through the Strait of Hormuz, one of the world’s most important energy routes. Saudi Arabia has responded by moving more oil across the country through pipelines to Red Sea ports, providing an alternative route to global markets.

That alternative is now also coming under pressure. Iran-aligned Houthi forces in Yemen have increased their activity near the Bab el-Mandeb Strait and threatened Saudi shipping and ports. This creates the risk that disruption spreads from the Persian Gulf into the Red Sea, placing two critical global shipping routes under pressure at the same time.

A complete interruption is not required to affect markets. Higher insurance costs, longer shipping routes and vessels being diverted around Africa can increase the cost of diesel, aviation fuel, freight, food and other imported goods.

These geopolitical risks can therefore keep inflation higher even if underlying economic demand begins to slow. They also make fuel security, energy infrastructure and reliable supply chains increasingly important economic and investment considerations.

This broader fuel-security question and its implications for inflation, interest rates, energy investments and portfolio protection will be a specific focus of our Investment Committee meeting next week.

Some positive signs from China

It was not all negative. Figures released by China’s General Administration of Customs showed that exports increased by 25% over the past year, supported by strong global demand for technology and artificial-intelligence-related products.

High-technology exports rose by more than 40%, semiconductor exports were particularly strong, and trade with the United States also improved.

This suggests that global technology investment and trade activity remain healthier than recent market weakness might imply. It may also be supportive for parts of the Australian resources sector.

However, China’s domestic consumption and property markets remain subdued. We therefore view the export figures as an encouraging development rather than evidence of a broad Chinese economic recovery.

The growing debt behind AI investment

An ongoing debate at an Investment Committee level is the increasing use of debt to fund the artificial-intelligence investment boom.

Analysis reported by Reuters estimates that the major US technology companies and Oracle have issued approximately US$220 billion of bonds over the past year. Meanwhile, research discussed by the Bank for International Settlements estimates that the five largest technology companies will spend more than US$1 trillion on AI during 2025 and 2026.

Some of this investment is also being financed through less transparent private-credit structures. This does not mean the AI investment cycle is about to end, but it increases the importance of distinguishing businesses funding expansion from strong cash flows from those relying heavily on continuing access to debt.

There is an interesting contrast emerging in Australia. The Reserve Bank of Australia (RBA) says data-centre construction has contributed meaningfully to the recent double-digit growth in business investment. At the same time, more traditional residential property development is under pressure from higher interest costs, rising construction expenses, weaker presales and softer property values in some markets.

The recent administration of Sydney-based developer Bathla Group has brought these risks closer to home. The group reportedly owes approximately $3.4 billion across more than 40 non-bank lenders, with work disrupted across numerous residential developments.

Bathla is an unusually large and complex case and should not be treated as representative of the entire private-credit market. The RBA has said it is monitoring the sector closely but does not presently see evidence of systemic financial stress.

While these developments reinforce the risk-reward decision we made in late 2024 to exit private-credit exposure, it does not mean we have stopped paying attention to the sector. Private credit has become a significant source of funding for companies, property developers and infrastructure projects, including data centres. Problems within this market can affect borrowers, property values, construction activity, conventional lenders and the pricing of credit more broadly.

The Bathla situation does not mean that every private-credit investment is unsound, but it demonstrates how quickly risks can emerge when a highly leveraged borrower encounters difficulty. Our Investment Committee will continue to monitor private credit as an important indicator of market and credit risk.

What it means for portfolios

The market weakness this week is better understood as a repricing of inflation and interest-rate expectations than evidence of an approaching financial crisis.

Higher bond yields are uncomfortable in the short term, but they also mean defensive investments now offer substantially better income than they have for much of the past decade.

Inflation, fuel security, higher long-term interest rates, China’s improving technology exports and the growing debt behind AI investment will all be discussed at our Investment Committee meeting next week.

Our focus remains on diversification, high-quality businesses with strong balance sheets and pricing power, and income investments that do not take unnecessary interest-rate or credit risk. We will also continue to assess whether portfolios are overly exposed to any single market or investment theme. 

We will report back on any material conclusions or portfolio changes arising from the meeting but until then, please remember this information is general in nature and does not take into account any individual’s objectives, financial situation or needs.

Sources referenced: Institute for Supply Management; US Bureau of Labor Statistics; US Federal Reserve; European Central Bank; China’s General Administration of Customs; Bank for International Settlements; Reuters; and the Reserve Bank of Australia.

Cheers 

— Scott