We adopt a tactical NEUTRAL stance on equities amid a challenging earnings season and tighter credit conditions. Regionally, we move to NEUTRAL across major markets and shift to a more defensive sector allocation.
We move to a tactical NEUTRAL stance on global equities (from LONG). The earnings reporting season is proving more challenging than expected, while credit conditions have tightened materially. High-yield spreads have widened to levels last seen at the outbreak of the Iran war and around Liberation Day. The move is therefore consistent with our view that widening credit spreads, rather than the level of interest rates, alone weighs on equities.
We adopt a more cautious asset-class stance while maintaining that the broader bullish case remains intact. We expect range-bound trading to persist until after the US midterm elections. A Democratic “blue sweep” appears increasingly plausible and, in our view, could prove the least favourable outcome for near-term market performance.
Our valuation model identifies real yields and credit spreads as the key sensitivities, with spreads making the strongest independent explanatory contribution. The four-factor specification explains approximately 58% of the variation in monthly changes in the logarithm of the forward P/E ratio over the most recent five-year window. A 50-basis-point increase in real yields is associated with a roughly 2% decline in the multiple, while a 100-basis-point widening in HY credit spreads is associated with a decline of around 6.6%, all else being equal. Declining leverage, stronger interest coverage and resilient profitability underpin our expectation that spreads will remain contained. Stable credit spreads and lower yields would ease the valuation pressure for which earnings growth must compensate.
Regionally, we move to NEUTRAL across all major areas. Ongoing geopolitical tensions in the Gulf keep us from turning LONG Europe, despite its relative insulation from AI-related market volatility. In Emerging Markets, expected US dollar weakness could partly offset the headwinds from AI-related uncertainty. We downgrade the US to NEUTRAL (from LONG), reflecting its high exposure to the AI theme and idiosyncratic political risks. We upgrade Japan to NEUTRAL (from SHORT).
At sector level, we adopt a more cautious and defensive stance, moving away from our previous cyclical tilt. We downgrade Banks and Semiconductors to NEUTRAL (from LONG). Banks are increasingly exposed to wider credit spreads, which could weaken credit quality and earnings expectations. Within Semiconductors, divergent fundamentals across AI computing, foundries, networking, analog and memory support selectivity over a broad sector position. We upgrade Media & Entertainment to LONG (from NEUTRAL), supported by its quality characteristics, strong cash generation and improving earnings momentum.
Strategically, we maintain our rolling 12-month OVERWEIGHT stance. Earnings delivery, cash generation and disciplined capital allocation remain central to the returns outlook. AI investment continues to absorb financial capacity unevenly, but improving free-cash-flow conversion through 2028 could gradually create greater scope for shareholder distributions.
The main risks are further earnings disappointment, additional credit-spread widening and persistent geopolitical tensions.
Cosimo Recchia
Senior Equity Strategist
Francesco Ponzano
Junior Equity Strategist
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