GOAL KICKSTART

Markets turned more defensive last week, with the sell-off concentrated in the AI/momentum equity complex. Equity volatility rose modestly, while treasuries rallied as ‘risk off’ pressures from AI equities and credit outweighed firmer inflation data (US September core CPI +0.33%) and crude oil prices returning above $100/bbl, pushed by restocking demand. Our sentiment and positioning indicator fell to the 46th-ile, its lowest level since April. Investors will closely watch US/Euro Area PMIs, UK CPI and unemployment, and Wednesday’s vote on the EU’s short-term 2027 budget. Our Risk Appetite Indicator has declined sharply over the past 3 weeks and has turned negative for the first time since March 2026. All five sub-components declined over the past month (Exhibit 1): credit and equity vol subcomponents led initially, before equities, bonds, and FX further contributed to a large decline last week. In the ‘risk off’ shift most of the AI risk exposures across asset have suffered (Exhibit 2), including AI Leaders (vs. laggards), Momentum (vs. low vol) and AI (vs. ex-AI). Last week global AI, Asia AI/semis (particularly Korea) and Momentum sold off the most, while ex-AI, selective European indices (including SMI, FTSE), ex-cyclicals/low-beta exposures rallied (Exhibit 3).

European and US equity strategists also highlighted Global Quality gaining ground in the current backdrop, favoring strong balance sheets and resilient margins from the fundamental standpoint. Concerns on AI capex returns and funding are increasingly showing up in credit: CCC-BB spreads, hyperscaler CDS and neocloud OAS have all widened, with the latest move particularly sharp for neocloud issuers (Exhibit 4)—our credit strategists see those at the epicentre of the current funding-cost debate, with the impact most pronounced in USD HY. The large beta-adjusted outperformance of Tech and Momentum equities vs. their credit counterparts has started to reverse, while more defensive equity exposures (low vol, dividend aristocrats) as well as S&P 500 equal-weight have moved in the opposite direction (Exhibit 5). The pickup in equity vol has also been concentrated in Tech-heavy exposures: Nasdaq vol has risen sharply relative to Russell, while Korea/Taiwan/semiconductor vol has also turned higher, both outright and relative to S&P 500 vol (Exhibit 6). We have shifted tactically (3m) to OW equities alongside OW cash and we remain UW credit/N duration. Near term there might be more volatility due to AI concerns, Middle East tensions, and midterm elections but we think earnings support with lighter positioning and lower valuations should help equities into year-end. Over a 12m horizon we give credit to balance and are OW equities/bonds and UW credit. Within equities, we continue to favor a barbell of selective global Tech and bond-like equities. Recent AI-related equity and credit weakness has started to restore duration’s role as a hedge to the AI theme. As recently discussed, elevated dispersion continues to keep the VIX low relative to other risk measures, including CDS—making VIX call spreads attractive as a broad, tactical downside hedge.