Equities remain supported by strong earnings growth, even as rate expectations have shifted from cuts to hikes. As such, the durability of earnings growth will be increasingly important. We are wary of potential near-term volatility, but we continue to see strategic upside in equities.

Eli Lee
Managing Director,
Chief Investment Strategist,
Bank of Singapore

History suggests that equities often face headwinds during the early stages of a new Federal Reserve (Fed) tightening cycle and in the lead-up to US midterm elections. Uncertainty surrounding crude oil prices, a key driver of inflation expectations and bond yields, could also contribute to bouts of market volatility. While these factors warrant caution in the near term, they do not alter our constructive long-term view. We continue to believe that the equity bull market has further room to run, supported by resilient economic growth, healthy corporate fundamentals and powerful secular tailwinds.

Central to our positive outlook is the accelerating adoption of artificial intelligence (AI), which has triggered one of the largest capital expenditure cycles in recent history. The rapid buildout of AI infrastructure is supporting both US and global growth while driving robust earnings expansion. Strong earnings have largely offset the impact of higher bond yields and valuation compression, allowing equities to continue advancing despite the market's shift from expecting rate cuts to pricing in additional tightening.

Looking ahead, we expect AI investment momentum to remain strong through 2027 as development and adoption continue to accelerate. While some have called for a coordinated slowdown in AI development, we believe a more likely outcome is greater oversight, governance and safety guardrails. Such measures would increase rather than reduce computing requirements, reinforcing demand across the AI ecosystem and supporting the long-term growth outlook for corporate earnings and equity markets.

Higher interest rates nevertheless warrant monitoring. Although the direct impact on corporate profitability should remain manageable given the prevalence of fixed-rate and long-dated debt, elevated borrowing costs may weigh on more leveraged companies and sectors not directly benefiting from the AI-driven investment cycle. Geopolitical risks and election-related uncertainties could also generate periods of volatility. However, corporate balance sheets remain generally healthy, and profit margins continue to hold above historical averages.

Against this backdrop, we maintain a moderately constructive stance on equities. We remain Overweight US equities, where the AI-driven earnings story remains most compelling, Neutral on Asia ex-Japan and Japan, and Underweight Europe. Within Asia, we favour China, Hong Kong, Taiwan and Singapore, with Taiwan particularly well positioned to benefit from its pivotal role in the global AI supply chain.

US – Looking through the rise in yields

Rising long-end yields could put pressure on equity valuations, particularly P/E multiples. That said, we expect robust US growth prospects to provide a cushion, allowing equities to withstand higher yields before valuation concerns become more pronounced. This resilience is supported by strong AI-related capital expenditure and earnings growth, which continue to underpin our constructive long-term view on the equity bull market.

Encouragingly, earnings growth is also becoming more broad-based. Beyond the largest technology names, the median stock in the Russell 3000 Index has shown improving earnings-per-share (EPS) growth over recent quarters. This broadening of earnings participation should help create a more durable foundation for further equity market gains.

While history suggests that US equities often face headwinds during the midterm election season, markets have typically staged a relief rally in the months following the elections, regardless of whether single-party control of the White House and Congress is maintained. As election-related uncertainty fades, we expect volatility to moderate, allowing investors to refocus on corporate fundamentals. Taken together with the improving earnings backdrop, this keeps us constructive on US equities.

Europe – Caution warranted but allocation justified

With interest rates remaining elevated and political uncertainty rising, European equities are likely to remain range-bound or face near-term pressure in the absence of a meaningful positive catalyst, such as a de-escalation of tensions in the Middle East. Historical analysis suggests that, since the onset of the latest Middle East conflict, a 10bp increase in the 10-year US Treasury yield has been associated with roughly a 1.0% decline in the STOXX 600 Index, while a similar rise in German Bund yields has corresponded to an approximately 1.2% fall. Real Estate and Consumer-related sectors appear particularly vulnerable, exhibiting sensitivities around 1.5 times that of the broader market.

Despite these headwinds, European equities retain several attractive qualities. The region could benefit from any market rotation away from AI-related beneficiaries, given the more diversified composition of European benchmarks, which offer meaningful exposure to Financials, Industrials, Materials and Consumer Staples. Investors also have access to a range of high-quality global champions with substantial revenue exposure outside Europe, helping to diversify earnings sources. In addition, the relatively attractive dividend yields available across European markets can provide an important buffer during periods of heightened volatility.

As such, we continue to view European equities as an important component of a diversified portfolio. Looking ahead, however, investors should remain mindful of Europe’s unusually busy 2027 electoral calendar, which could concentrate political risks and contribute to periods of market uncertainty.

Japan – Macro events dominance lingers on

Japanese equities traded broadly sideways over the past month, with Communication Services, Energy and Financials outperforming, while Consumer and Materials stocks lagged. Value stocks outperformed Growth as investors positioned for a backdrop of higher oil prices, rising interest rates and currency volatility.

As widely expected, the Bank of Japan (BoJ) raised its policy rate by 25bp to 1.25%. Market pricing currently implies around a 70% probability of a further rate hike in December, reinforcing expectations of continued policy normalisation.

Banks remain among the clearest beneficiaries of this normalisation cycle, supported by improving net interest margins and solid loan growth, although investor positioning has become increasingly crowded. Conversely, interest rate-sensitive sectors such as real estate and construction, as well as highly leveraged companies, could face headwinds from higher financing costs.

Domestic consumption, however, may receive a boost from the planned reduction in the consumption tax on food and beverages from 8% to 1%, effective April 2027. Beyond the near-term macro backdrop, we continue to favour structural investment themes, including opportunities linked to the 17 strategic industries identified by the Takaichi administration. As the earnings season approaches, we expect investor focus to gradually shift from macroeconomic developments towards corporate earnings growth and company-specific fundamentals, providing the key catalyst for Japanese equities through the remainder of October.

Asia ex-Japan – Navigating elevated oil prices and US yields

Investors are increasingly focused on the implications of higher US bond yields, alongside persistently elevated energy prices. In this environment, China’s onshore equity market appears relatively well positioned within the region, supported by its lower dependence on oil, the relative insulation of A-share markets from foreign capital flows, and the more limited impact of higher fuel prices on consumers due to strong electric vehicle adoption and regulated fuel price pass-through mechanisms.

By contrast, while valuations across ASEAN markets remain broadly attractive, the investment backdrop is becoming more challenging as external balances come under pressure in some economies. Within Asia ex-Japan, we continue to favour China, Hong Kong, Taiwan and Singapore equities, where we see comparatively stronger fundamentals and more compelling risk-reward opportunities.

China/HK – Looking past the US-China Presidential Summit

China’s onshore A-share market outperformed Hong Kong and offshore China equities over the past month, reflecting its lower sensitivity to rising US long-term yields and reduced exposure to foreign capital flows. Performance across sectors was notably polarised, with innovative growth segments such as Healthcare and Information Technology outperforming alongside yield-supported value sectors including Financials and Utilities.

Historical experience from the previous two US rate-hiking cycles suggests that higher US interest rates can create headwinds for Hong Kong and offshore China equities through tighter financial conditions and valuation pressures. However, their market performance has ultimately been driven more by domestic fundamentals, including the strength of economic growth, policy developments such as stimulus measures or regulatory tightening, and geopolitical factors, particularly developments in US-China relations.

While rising US yields remain an important consideration for investors, we believe the outlook for China and Hong Kong equities will continue to be shaped primarily by the trajectory of economic activity, policy support and corporate earnings, rather than by US interest rates alone. This underscores the importance of focusing on underlying fundamentals amid an evolving external environment.

Market expectations surrounding President Xi’s state visit to the US were relatively subdued, with investors largely anticipating that the existing trade truce would remain intact and broader stability in bilateral relations would be maintained. As a result, we expect markets to look beyond the Presidential Summit and remain focused on underlying economic and corporate fundamentals.

In Hong Kong, ongoing policy efforts to strengthen the city’s position as a leading offshore RMB hub and support the internationalisation of the renminbi should provide a structural tailwind for the financial sector. Banks with strong RMB franchises are particularly well placed to benefit from expanding cross-border RMB activity, while exchanges and brokerage firms could also gain from deeper capital market connectivity and increased offshore RMB-related business flows.

Singapore – Defensive edge

We maintain our Overweight stance on Singapore equities, supported by their defensive characteristics, the strength of the Singapore dollar, and ongoing efforts to enhance the attractiveness of the local equity market. While valuations for the Straits Times Index (STI) are no longer particularly cheap, the market continues to offer relative appeal from an income perspective. Although the STI’s 12-month forward dividend yield has compressed to below its 10-year historical average, it remains attractive compared with many major global equity indices.

We continue to view Singapore banks as core holdings for domestic investors. They remain well positioned to benefit from a higher-for-longer interest rate environment, while their defensive qualities and strong fundamentals should continue to attract foreign capital seeking relative stability amid heightened global uncertainty.

While valuations across the S-REIT sector remain undemanding, a sustained re-rating is likely to require a clearer shift in the interest rate outlook. In the meantime, investors should remain selective, focusing on S-REITs with the ability to deliver sustainable growth in core distribution per unit while maintaining prudent balance sheet management and financial discipline.

Global Sectors – Sectors and styles in a rising rate environment

A rising interest rate environment is likely to have varied implications across sectors. Financials are typically among the primary beneficiaries, although the extent of the benefit for banks will depend on whether the yield curve steepens or flattens and the resulting impact on net interest margins. Cash-rich companies may also be relatively resilient, as higher rates enhance returns on surplus liquidity. Conversely, rate-sensitive sectors such as Real Estate and parts of the Consumer space may face headwinds from higher financing costs and softer demand. Highly leveraged companies with weaker balance sheets could come under greater pressure, while speculative growth stocks with long-duration cash flows are also likely to see valuation multiples challenged.

From an investment style perspective, a gradual and shallow rate-hiking cycle continues to support our preference for Quality Growth. However, should rate increases become broader and more aggressive, the case for rotating towards Low Volatility strategies would strengthen. Rather than pursuing the highest-yielding stocks, we favour companies that offer a combination of sustainable dividends, earnings growth and resilient cash flow generation.

Importantly, investor yield should not be viewed solely through the lens of dividends. Companies with strong balance sheets may also return capital through share buybacks and special dividends, making total shareholder yield a more comprehensive measure of value. In a higher-rate environment, businesses with strong pricing power, robust free cash flow and limited refinancing needs are likely to be best positioned, as they are better able to protect margins, maintain financial flexibility and self-fund future growth.

AI safety concerns in the spotlight

Concerns have emerged over the outlook for AI compute demand following calls from leading AI laboratories and international organisations for a more measured, safety-first approach to AI deployment. Nevertheless, we remain constructive on the long-term demand outlook for AI infrastructure and compute capacity.

First, any voluntary slowdown by a small number of frontier AI developers is unlikely to be sustained in the face of intense competitive pressures, particularly from open-source models and alternative developers that may continue to advance at a rapid pace. Second, the emergence of recursive self-improvement (RSI), whereby AI systems are increasingly able to enhance their own capabilities, has the potential to unlock entirely new addressable markets over the coming years, much as advances in coding assistants and agentic AI workflows have expanded use cases over the past 18 months.

Third, the continued decline in token and inference costs is accelerating the development and adoption of AI-powered applications. Lower costs improve accessibility, broaden the range of commercially viable use cases and ultimately drive greater demand for AI services. Importantly, falling token costs do not necessarily threaten the economics of leading AI developers, as improving efficiency can support both adoption and profitability.

Taken together, these factors reinforce our view that demand for AI compute capacity is likely to remain robust over a multi-year horizon. That said, regulatory developments remain a key risk to monitor. More stringent oversight of AI model development, deployment or training requirements could have a meaningful impact on the pace of innovation and, in turn, future demand for AI infrastructure and compute resources.