We fundamentally believe that AI and the technology revolution have further potential to increase the returns and efficiency of companies and increase profitability. But whether these are the same stocks that have driven the market so far is another question. We always look at the stock market and asset classes with an eye on three cycles: The structural cycle, the business cycle and the sentiment cycle.

The structural cycle has this tailwind, partly due to AI, which can support the markets. In the business cycle, we saw this year that the equally weighted S&P 500, or the S&P 500 without the Magnificent Seven, did not perform exceptionally well. The market was very focused on the potential structural AI winners. This was also reflected in the sentiment cycle. In the summer, many of our indicators across asset classes, but also across investor categories, showed that there was a lot of euphoria.

The correction that we saw in early August, and again in early September, was based on a combination of several factors: A slowdown in the US economy and negative macro surprises. This naturally weighs on risk appetite. Then came the outlook of one of the big tech companies, which did not fully convince the markets. One could argue that this was a very healthy correction. If the rally had continued, the risk that such a correction could be significantly more significant at some point would have continued to grow.

So this correction came at the right time?

This correction actually came relatively early. If you look at the valuations of the Magnificent Seven, they are actually not that high in aggregate. Certainly not comparable to what we saw in the 2000 tech bubble. The return on equity of the S&P 500 is much higher at the moment than it was back then. And what is very important is that the profitability of the Magnificent Seven is significantly higher. As long as they remain so profitable, and meet their growth rates and expectations accordingly, they will be able to stabilise.

Have the expectations of a company like Nvidia or the Magnificent Seven perhaps grown a little too high so that, at some point, they can no longer be met?

We have seen many corporate numbers in the last three or four quarters that were often above expectations, not only in tech stocks but also in the broader market. Now, in the second quarter, the sentiment was euphoric, and three factors worried us. The first was the negative surprise from data from the US, particularly on the labour market. The second was the very high level of optimism in AI and with regard to the Magnificent Seven, and the third was the US elections, which are getting ever closer. That is why we have become a little more tactically cautious, and over the summer, we moved equities in the asset allocation from overweight to neutral.

Small caps, such as those found in the Russell 2000, have recently had a tailwind after having been at a disadvantage compared to the big caps for a long time. Will this recovery continue, or could it soon come to an end in view of economic uncertainty?

It is actually the case that in periods of interest rate cuts that are not followed by a recession, which is our base scenario, one should actually see a broadening of the stock market rally. Parts of the stock market with high levels of debt have suffered dramatically in the past two or three years, and that includes small and mid-caps. If the interest rate cuts come now, then the areas that have performed poorly either due to high levels of debt or high sales leverage could recover. But one also has to remain a little cautious. This is probably not an opportunity for several quarters but an area that could benefit at the beginning of this interest rate cuts cycle.

I read an article by you on the subject of „The optimal portfolio“. How does that look for you in these times, and perhaps a little longer term for the coming decade? What should be in there, and what should not be?

For us, it always starts with the 60/40 portfolio. 60% stocks, 40% bonds. That is how the majority of investors in the USA are positioned, and over the past 100 years that has been very close to the optimal portfolio with the highest risk-adjusted returns. In Europe, the share of stocks is usually somewhat lower and that of bonds higher, so we are talking more about a 40/60 portfolio. This is partly due to demographic reasons. In the past two or three years, multi-asset portfolios have had major setbacks, so that sometimes doubts are raised as to whether such portfolios still have any advantages at all. More stocks have brought higher returns. However, there have also been unusual movements in recent years due to inflation. We, therefore, think that 60/40 portfolios are still very useful in principle. The problem at the moment is that a large part of the interest rate cuts have already been priced in. It, therefore makes sense to diversify more over the next three to six months instead of just relying on stocks and bonds. A second factor is fiscal policy, which has become much more expansionary globally in recent years, both in the US and in various other countries. This means that long-term interest rates are unlikely to fall as much because central banks have to price in higher risk premiums for fiscal policy.

So the solution for you is even greater diversification?

Yes. We are adding more alternative so-called „haven investments“ to the portfolio. In the past two years, gold and the Swiss franc were attractive. The yen could also come back. A 60/40 portfolio, supplemented by such relatively safe investments, is the optimal portfolio for the next decade for us.

What do you think are the significant issues that will shape this next decade?

We have three challenges that we, as a society and as investors, must find a solution to. These are decarbonisation, deglobalisation, and demographic development. These three Ds, as we call them, entail the risk of triggering more inflation and more volatility. In the past 30 years, inflation has been relatively stable at a low level. In 2022, there was a warning shot when it became clear that the risk of inflation could come back. That is the first issue that needs to be addressed in the portfolio. And another is, of course, innovation. We have the AI ​​revolution, which is creating a lot of options for companies and economies. But we also have other innovations, e.g. in the healthcare sector and the field of renewable energies, some of which are also being accelerated by AI. Innovations are becoming increasingly important in a world that is limited in terms of economic growth.

What does that mean for the optimal portfolio?

The portfolio must reflect both inflation and innovation. For the next decade, we assume that the optimal portfolio should consist of 1/3 stocks, 1/3 bonds and 1/3 real asset classes. On the stocks side, it is essential to reflect the innovations mentioned. Bonds should buffer growth risks. With tangible assets, for example, you can invest in infrastructure and possibly in the sharply fallen real estate values ​​that could now be stabilised by low interest rates. This can also be reflected in stocks, and then you quickly reach a stock ratio of 50% to 60% again – the rest goes into inflation-protected bonds – and so you are back to a 60/40 portfolio, which has been the optimal asset mix for the past 150 years.

Which sectors do you see as future market drivers? You just mentioned healthcare and infrastructure.

The global manufacturing sector, i.e. the processing industry, could be at the beginning of a new cycle if interest rates fall. Luxury stocks have also fallen sharply but have real pricing power in many areas.

Finally, let's briefly return to the US election. What impact do you expect on the stock markets? Will there be any significant impact at all?

There is traditionally a lot of uncertainty around elections. This can have an impact on the stock market. We are, therefore, cautious about restructuring portfolios around elections. Much will also depend on whether the winner will also have control of the House or Senate. Historically, the market usually starts to look at the issue about eight weeks before the election, which is around now.