Global Investment Committee's outlook: low risk no longer Nikko Asset Management October 2024   As the Global Investment Committee (GIC) convened on 26 September, our Q2 outlook for resilient though somewhat softer US growth had materialised. However, our US EPS growth estimates (consistent with strong but softer GDP growth) remained slightly more conservative than market estimates. Going forward, we perceive heightened risk to both growth (two-way) and inflation (upside) compared to our Q2 guidance. Nevertheless, our central near-term scenario remains for slowing but positive growth in the US, alongside slowly moderating prices. Key takeaways are as follows: We maintain our main view of benign growth in the US, accompanied by moderating inflation. However, we see heightened tail risks biased toward inflation for global markets and would look to diversify risk portfolios with assets resilient to inflation. We remain constructive on gold as a portfolio diversifier. We view Japanese equities favourably given comparatively reasonable valuations (vs. the S&P500 or ACWI) alongside multiple signals of Japan's structural recovery. We would favour an increasing bias toward domestic demand-related stocks as these may be more resilient in the face of any correction in US markets. We see limited upside in long-duration US bonds, thanks to front-loaded pricing of Federal Reserve (Fed) stimulus, and insufficient pricing of inflationary or fiscal risks into the longer end of the US yield curve. Due to the positive correlation between US bonds and stocks, bonds no longer provide adequate downside diversification. Moreover, a positive correlation persists among many global bond markets despite diverse interest rate trajectories. We view long-term bonds with caution. Q3 2024 in review: the "great dispersion" in stocks and bonds Over the course of Q3, the market experienced a change of course on several factors. Following a surprise rate hike from the Bank of Japan (BOJ) in July (the central bank took overnight rates to 25 bps), a downside surprise in US non-farm payroll data triggered speculation of imminent Fed rate cuts. This, in turn, led to the unwinding of speculative yen-funded "carry trades", triggering both a sudden drop in dollar-yen as well as unexpected volatility in Japanese equities--the target investments of short-term overseas investors utilising borrowed yen. Markets recovered quickly from the volatility, although dollar-yen appears to have corrected decisively lower from highs above 160. Domestic investors went bargain hunting as Japanese indices sold off and Japanese corporates used their large cash balances to buy back their shares at lower prices. Underweight institutional investors accumulated domestic equities to rebalance their portfolios while households, unfazed by speculative selling, continued to exercise the tax advantages that accrued to them under the New NISA. We convened an Extraordinary GIC at the time and shifted our guidance, primarily to allow for greater volatility. Aware that volatility tends to cluster and that markets may be at the threshold of a new volatility regime, we widened our ranges for both US GDP and the FOMC to admit downside risks. We also implemented new ranges for valuation (P/E) alongside existing earnings ranges for Japanese indices. Meanwhile, on the eve of the GIC on 26 September, markets had received news of surprise stimulus from China, on the heels of a larger-than-expected 50 bp rate cut from the FOMC on 19 September which had prompted bond markets to price in a succession of significant US rate cuts. Equity markets subsequently broke to new highs, even as bonds priced in a sombre macroeconomic scenario, though they barely reacted to the Fed's move on 19 September as the market had already priced in multiple 50 bp interest rate cuts. Meanwhile, toward the end of Q3, both Japanese stock markets and dollar-yen were influenced by speculation that Japan's ruling Liberal Democratic Party (LDP) would elect a new Abenomics-inspired leader (and thus prime minister). However, the LDP leadership vote on 27 September resulted in disappointment for the markets, which had to lower their expectations for the BOJ to end or indefinitely postpone its interest rate hike cycle. The LDP elected Shigeru Ishiba as its new leader and prime minister, who subsequently called a snap election for 27 October. However, as we noted in our insight, "Less may be more in Japan's LDP leadership contest", the situation is very different now than at the start of the Abenomics era when inflation struggled to turn positive. In Q3, we not only saw Japanese Q2 corporate earnings remain consistently strong but we also witnessed incipient signals of stronger consumption demand, backed by the advent of positive year-on-year (YoY) real wage growth. Global macro: growth risks persist, inflation tamer vs. Q2 on surface US: From a macroeconomic standpoint, there is not enough clear motivation from underlying economic indicators to price in an imminent US recession, even despite softening data. Although the GIC foresees US GDP growth dipping below the 2% level, our outlook is for YoY growth to remain above 1.5% in the year to September 2025. The US consumer has remained resilient, even despite a softer job market, with consumption among higher-income households assisted by the "wealth effect" of gains in US stocks. While much slower than in early 2024, the US continues to add over two million jobs to non-farm payrolls YoY (see "What the Fed's rate cut tells us about current financial conditions"), which is stronger than job growth typically tends to be immediately prior to a US recession. That said, the unemployment rate has triggered the Sahm rule (typically a forward indicator of recession), due in part due to the widening disparity between the household survey (which shows YoY job growth already in contraction), and based on which the unemployment rate is calculated and the establishment survey, which tabulates non-farm payrolls. Chart 1: Employment conditions in the US Source: Nikko AM, BLS Motivating the divide in part are disperse conditions between higher income households (where both job conditions and investment income are more supportive) and lower-income households, which are a higher proportion of the household survey than the establishment survey. Meanwhile, we see inflation as likely to stay on a gradual downward trajectory, although our median US core PCE outlook is for prices to show above 2% YoY growth over the course of the year to September 2025. Meanwhile, our voter survey shows a less dispersed central tendency for both headline and US inflation compared to Q2 as inflation subsides gradually. Notwithstanding, several members cite heightened inflationary tail risks. Many of the risks cited by voters have the potential to extend beyond the one-year outlook horizon. Macro vs. forward-looking financial market indicators: We are carefully observing the "great dispersion" of scenarios priced into financial markets, particularly in equities and bonds. We are unconvinced that the circular logic of aggressively lower rates could justify ever-higher equity valuations. This is particularly so given the messaging from the Fed. Although the FOMC did comply with market expectations for a "jumbo" cut in July, Fed Chair Jerome Powell continues to warn against assuming this would be the "new pace" of monetary easing in the absence of clear deterioration of economic conditions. Meanwhile, should economic conditions deteriorate (which is the bond market's signal) we are doubtful that the optimistic scenarios priced into the equity markets would indeed come to pass. Japan: Despite financial volatility in August, Japanese GDP appears to be on a trajectory to continue growing above-trend (potential GDP has been estimated at around 0.6% by the BOJ). Nonetheless, the median GIC voter offers more conservative estimates of Japanese GDP growth than in Q2 (no longer above 2% YoY) thanks in part to slower--albeit positive--growth in the US and other export markets. Meanwhile although headline CPI is foreseen dipping below 2% as early as the September quarter of 2025 with imported price inflation allayed by a slowly strengthening yen, our median GIC outlook is for ex-food inflation to remain above 2% over the year to September 2025. Euro area: The median GIC voter meanwhile foresees Eurozone GDP growth as likely to break above 1% YoY and remain at these levels over the year to September 2025, although both headline and core inflation are likely to remain stubbornly in excess of the European Central Bank (ECB)'s 2% medium-term target. However, immediate upside inflationary risks have been somewhat downgraded since the Q2 GIC, when much greater upside dispersion was seen among voters' estimates of future European inflation in both headline and core HICP. China: were it not for China's recent fiscal and monetary stimulus packages, GIC voters would have likely downgraded their GDP growth outlook, which they expect to still remain in the upper 4% range (but under 5%) over the year to September 2025. According to GIC voters, compared to the beginning of Q3, when stimulus was not priced in, moves by the Fed and the People's Bank of China (PBOC) have shifted the growth outlook. At the beginning of Q3, growth was perceived to come from abroad while now there is much more focus on domestic recovery. Meanwhile, communication between the PBOC and the government, which had previously been much more compartmentalised, now demonstrates greater coordination and a tone of shared urgency among Chinese officials. Their aim extends beyond simply stemming the decline in the housing market, focusing instead on stimulating domestic demand growth. Voters note that Chinese stimulus has been delivered at a time when markets are particularly sensitive to easing, though the size is half of what was delivered in 2009 (CNY 4 trillion vs. CNY 2 trillion in debt-funded fiscal easing in 2024) when the economy was one-third the size it is now. GDP growth is now less likely to falter near the 4% level (compared to the 5% target), particularly in the near-term--specifically, in the fourth quarter of 2024 and the first quarter of 2025. That the package also includes consumption coupons issued by an administration that once eschewed what it deemed "welfarism" underscores the priority for China to keep social unrest at bay given its sluggish domestic economy. Nonetheless, the outlook for headline CPI remains on the 1% handle, with core CPI still foreseen below 1% YoY over the year to September 2025. This is because voters perceive difficulties for China in lifting prices successfully; rather, attempts to date to allay weakness in the much greater consumer economy with investment in industry and export could potentially mean some degree of exportation of deflationary price pressures on exported Chinese goods. However, the impact of such pressures on trade partners could be limited in comparison to the early 2000s given today's higher relative price levels, reduced global trade openness and rise in trade barriers. That said, exported deflationary pressures are not always persistent. Though many Chinese firms do compete on price to gain market share, once gained, price increases often follow in an attempt to expand margins. Interest rates: the power of financial markets, a double-edged sword FOMC: In line with our relatively softer growth and inflation guidance over the year to September 2025, we have also downgraded our FOMC outlook relative to Q2. As mentioned in the "macro" section, softer indicators--particularly pertaining to US jobs--reinforce the need for further rate normalisation, as also apparent in the FOMC's own downgraded "dot plots" for growth, inflation and rates. The median GIC voter took the Fed's own forecast at face value to bring rates another 50 bp lower by the end of 2024. This is less dovish than the outlook currently priced into the bond market, which foresees potential for up to 75 bps in cuts by the end of 2024. Subsequently, the GIC foresees roughly 25 bps of easing per quarter, with a median outlook of 3.7% and an interquartile range between 3.45% and 3.95% by the end of September 2025. BOJ overnight rates: In Q2, we had priced in a partial but not a full probability of a July rate hike, which we saw as a modest surprise. However, following our August review, we saw little risk of the BOJ following up its surprise July hike with immediate additional tightening prior to gauging the impact of its move in Q3. Moreover, the BOJ called out both financial markets volatility as well as uncertainty abroad (e.g. in US growth) as one reason to remain on hold in September. Much like the influence that the markets appear to have had on the Fed's "pre-emptive" 50 bp cut, we see the BOJ's stance as being much more market-conscious than it was prior to the volatility experienced in early August. We do foresee potential for another rate hike before year-end, but such a move would most likely come after the October inflation data is published. According to the media, consumers will face price hikes on 2,900 food and drink items in the month of October (the broadest price increase in 2024 so far), as firms pass along higher raw material costs to consumers. GIC voters are therefore pricing in prospects of another hike prior to year-end (with the median guidance at 0.3%). There remains the risk that if financial market volatility resurges, the BOJ may remain on hold--all else being equal--at any point over the coming year. Conversely, if inflation surprises to the upside, there is also the risk that the BOJ could deliver a larger hike; our voters attribute a 25% or less chance that rates may rise to 0.45% before the year-end. Subsequently, the median GIC voter foresees rates as likely to rise to 50 bp by June 2025, and to 75 bps by September 2025. ECB: After the Q2 median guidance of 3.65% for the September-end refinancing rate came in close to the actual outcome, the GIC modestly downgraded its ECB outlook for the coming year. The Fed's larger-than-expected rate cut in September may have opened the door for more aggressive easing by the ECB. The median GIC voter predicts that it is somewhat likely for the ECB to reduce overnight rates before the year-end, with the interquartile range by the end of December 2025 at 3.075% to 3.575%). Nonetheless, given persistent services inflation, especially in Europe, the rate cut outlook is more conservative compared to the FOMC. Our median voter foresees a further 75 bps of cuts as likely in 2025. This compares to the FOMC's 80 bps foreseen for 2025, in addition to the 50 bps of cuts in Q4 2024. 10-year interest rates: Despite the uncomfortable positive correlation between equities and 10-year bond prices (with long-term bonds affording insufficient diversification from market risk), it is hard for participants in the bond market to "fight the Fed" given the apparently strong influence financial markets have on policy. This may paradoxically dilute the power of financial market indicators, including term structures of interest rates, as forward indicators of economic activity. Moreover, the positive correlation across geographies in longer-term bond markets is also apparent, even despite disparate policy trajectories. For example, in spite of improved prospects for near-term BOJ hikes since Q2 as priced into the short end of the JGB yield curve, the term structure of Japanese yields has flattened modestly since July, possibly influenced by Fed easing. Meanwhile, long-term US Treasury yields have declined even though the inversion between the 2- and 10-year benchmark Treasury yield has corrected. GIC voters foresee limited movement in 10 year Treasury yields from their current levels, even despite additional FOMC cuts, due to many of the cuts already being priced into the bond curve. Likewise, voters' central scenario is for little movement in 10-year Bunds over the coming year. One significant caveat--though not a central scenario among voters that inflation will disrupt the Fed's rate cut trajectory-- inflationary surprises and fiscal risk have registered higher than in Q2 in both probability and impact among voters' tail risks (see "Risks to Our Outlook* below). Foreign exchange: gradual yen appreciation Following volatility in August, we adjusted our outlook on the Japanese yen to allow for greater appreciation by the currency, as did the market as a whole. Partly responsible for this outlook adjustment was the prospect for narrowing yield differentials as the Fed eased and the BOJ tightened. Also, after observing one round of carry-trade unwinding and observing that market volatility tends to cluster, we upgraded the potential for volatile moves; volatility tends to come alongside yen appreciation. Meanwhile, the dollar's prospects have been downgraded modestly across currencies. The downgrade is less pronounced against the euro, pound and Australian dollar compared to the yen. Noting that the September 2024 BOJ Tankan survey released on 1 October references a fiscal year-end dollar-yen rate of 144.31, which is reasonably close to the spot rate at the time of writing, additional appreciation may impact exporters' overseas revenues, which we cover in the Japanese equities section. Mild upside to commodities, dispersed view on gold and oil In line with the downward adjustment in oil prices thanks to supply and demand factors, the GIC downgraded its Q2 assumptions on Brent crude, foreseeing oil to remain below USD 80 per barrel for the year to September 2025. Any upside surprise, meanwhile, may result in an upgrade to inflation expectations. While this is not our central scenario, we do see rising tail risks connected to geopolitics, including violence in the Middle East. As its central scenario the GIC foresees mild upside to commodity prices over the coming year. Meanwhile, we expect the quest for diversification away from market risk, along with the inconvenient positive correlation between equities and US Treasuries (a traditional risk haven) will prove very supportive for gold in the coming year. Although the market prices a correction to near USD 2,500 per ounce over the next year, the GIC median voter sees potential for gold to rise above USD 2,700, with a 25% chance of the precious metal climbing to USD 2,800 or higher over the year to September 2025. Earnings growth and equity valuation: making way for higher asset volatility Over the immediate horizon, the Fed's pre-emptive rate cut has had positive effects. Ongoing stimulus may continue to offer potential for resilient earnings growth from US stocks over the year to September 2025. We foresee double-digit YoY earnings growth still remaining intact over the year to September 2025. However, we also flag risks associated with ongoing market concentration (see "Risks to Our Outlook" below). Although our earnings outlook remains roughly in line with consensus, we foresee the potential for valuations to overshoot near-term due to Fed stimulus, and then gradually moderate over the course of the year to September 2025. We also anticipate potential for rebounds in lower-valued indices, such as the STOXX and Hang Seng. We believe that the latter can capitalise on its recent trough as Chinese stimulus takes effect and earnings growth recovers. But we expect valuations to remain on a downtrend for the STOXX, while we see earnings recovering over the course of the year to September 2025. Japan equities: low valuation + earnings growth + volatility = opportunity Although we foresee a rising trend in Japanese earnings and some adjustments in valuation over time, we expect volatility and dips in price creating significant opportunities for new purchases among longer-term investors. Notwithstanding the volatility, we see potential for broad-based Japanese corporate earnings growth, plus significant ability for the index to regain ground after sharp dips. This is due not only to comparatively reasonable valuation relative to US stocks, whose P/E ratios are well above their historical 20-year range, but also Japan's strong structural growth backdrop. This is evidenced by the gathering momentum of domestic consumption and investment alongside improving governance among corporates. We also note the presence of structural buyers in the form of domestic corporates buying back their own shares, institutions topping up domestic shareholdings to meet allocations and households exercising the tax advantages inherent in the new NISA. However, we do not discount the potential for interim negative surprises, particularly among large exporters, given the smaller buffer that current yen rates provide to exporters in terms of overseas revenues and investment income windfalls. Broader price ranges reflecting reactions to earnings surprises and valuation shifts: In August, we had introduced ranges not only for EPS growth but also for P/E ratios. We calculate price ranges taking into account the combined maximum and minimum impacts of earnings growth and valuation shifts. The highs within the price range represent our anticipated upper end of index fluctuations due both to earnings surprises and valuations, which we believe will experience bouts of interim volatility so long as market trading remains dominated by foreign investors (who on aggregate trade more frequently than domestic investors) even though many classes of domestic investors are likelier to buy and hold. Chart 2: Percentage of total TSE trading volume by foreigners Source: Nikko AM, Tokyo Stock Exchange Risks to our outlook: harbingers of inflation Despite the generally benign outlook to global growth and inflation, our voters cited the following heightened risks that were biased toward the inflationary upside: Inflationary outcomes from US elections: almost every voter cited risks related to and following US elections, along with risks associated with increased inflation. Voters generally assigned this tail risk a higher probability than in the June GIC, designating subjective probabilities of between 15-30% to inflationary policies such as trade tariffs and draconian limits on immigration. US immigration, incidentally, has been recognised in recent statements by the FOMC to broadly dampen the impact of cost-push wage inflation. Another inflationary risk cited was that of unsustainable fiscal expenditures, which could impact the longer end of the US interest rate curve. One voter pointed out that an outcome where both the Executive and Legislative branches were aligned (though lower in probability than a mixed result) would be more likely to lead to unsustainable fiscal expenditure, which might be received positively by markets on impact and offer an anticipatory boost. At the same time, this outcome might also heighten the risks further along the line of dislocation in bond markets, should overseas investors, who finance the US current account deficit, perceive long-end US yields as an insufficient premium to cover the forward-looking risks inherent in rising debt-to-GDP ratios of above 120%. Political violence and geopolitical risk: Escalating political violence not only between Israel and Palestine but now also involving Lebanon, as well the ongoing Russia-Ukraine war, have prompted GIC voters to upgrade geopolitics as a source of risk, potentially also contributing to inflation. Although our main scenario is for oil prices to remain subdued below USD 80, this could change if political violence spurs fears of supply risks. GIC voters have assigned around a 20% probability to a middle to high impact outcome where political violence escalates and gives rise to disruptive inflationary pressures. Two-sided risks for AI earnings and concentration in technology: Several voters cited the potential for risks surrounding the concentration of US equity returns in technology, and specifically in AI-related stocks. The highest probability tail risks (rated middle impact) were assigned 25% and involved the risk of investors becoming impatient and downgrading technology due to the low current ROI on AI-related capex, and therefore imposing a valuation downgrade despite positive current earnings. The risks surrounding anti-trust cases against large technology firms, as well as potential for re-rating of revenue expectations among tech firms, was also assigned a 15% probability. One voter also cited a high risk of 40% subjective probability that negative operating leverage for companies not exposed to AI, coupled with diminishing pricing power and an inability to compete on price, as well as rising input costs (including labour) has the potential to undermine earnings in sectors other than tech. This would increase the US markets' already high reliance on the sector to generate earnings growth. On the upside, one voter assigned an 18% subjective probability to the potential that already implemented investment in AI, alongside aggressive easing from the Fed, could provide the US with a long-awaited productivity boost. This could lead to an upgrade to non-tech sector valuations, which have been lagging to date. Self-referential US market rally reverses, negatively impacting real growth: The risks associated with any broader unwinding positions in the US tech sector are unlikely to be as benign than those associated with the unwinding of the Japanese "carry trade". In Japan, the base of buyers to date has been narrow (and structural buyers are not yet overweight); Japanese households' exposure to equities is below 15% of their balance sheet, while their cash holdings total over 50%. Conversely, in the US, households' exposure to equities and mutual funds is above 40%. This means that potential for a large market correction to impact real US GDP is greater. To date, the "wealth effect" appears to have supported US consumption above and beyond employment income growth. In the event of a major US market downturn, a 20% subjective probability was assigned to the likelihood of the wealth effect having a negative impact upon US consumption. Investment strategy conclusion: stay invested, insure against inflation Our anticipated economic outlook remains benign. Although we anticipate a slowdown in US growth, we do not foresee recession as imminent, with the Fed's pre-emptive rate cut already contributing to accommodative financial conditions due to its anticipatory impact on financial markets. Accommodative financial conditions remain supportive near-term. Meanwhile, though it remains difficult to anticipate the timing of market-related corrections, we also signal heightened tail risks associated with policy uncertainty surrounding elections in the US as well as the potential for even small disappointments in economic data and policy to exercise a greater impact on asset markets and therefore growth in the future. We see the risks as biased toward the inflationary, and also foresee the disparity in outlooks priced in by the US bond and stock markets as ultimately unsustainable. In the event of upside risks to inflation, holding stocks (however volatile) may help protect the future purchasing power of investors, while upside may be limited for bonds, even if central banks do deliver easing as anticipated. For this reason, we continue to see demand for assets that are typically resilient to inflation that may also provide diversification hedges against US market risk. We favour gold and increasing exposure to Japanese domestic demand, which is showing signs of sustainable structural recovery and is less correlated with US growth and stimulus than export-oriented firms. The GIC's guidance ranges may be found in Appendix 1 of this document. A note on changes to the Global Investment Committee Process: In June 2024, we made changes to the Global Investment Committee, as to align our quarterly Outlook more closely with the views underlying our portfolio investments. In lieu of forecasts, we have chosen to provide guidance ranges for indicators and indices that we feel most closely relate to the asset classes we manage. In place of forecasts the Global Investment Committee now provide aggregate guidance at the median for our central outlook, and at the 25th and 75th percentiles. The asset classes represented in our Outlook can change over time, depending on what is most representative of our active investment views. In the event full ranges are not available, this may be interpreted as to mean that the asset class is not a central focal point for our highest conviction investment views. Appendix 1: GIC Outlook guidance Global macro indicators Central bank rates, forex, fixed income and commodities Equities Funds operated by this manager: Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund Important disclaimer information Please note that much of the content which appears on this page is intended for the use of professional investors only.

Change as the only constant: investing in a world in transition Nikko Asset Management August 2024 Q1: Does the AI investment theme still offer significant long-term potential? When we are confronted with truly significant change, we can often react in ways that are not entirely rational. If the change represents a perceived threat, our fight or flight response can be triggered, leading us to resist the change or ignore it in the hope that it might go away. While there are clearly risks, resisting the opportunities presented by artificial intelligence (AI) and ignoring its development would seem to be dangerous for investors. Bill Gates has been quoted as saying that the impact of new technologies is often overestimated on a two year view but greatly underestimated over time periods of ten years or more. When we view technological development in its long-term context, the change it represents can become less overwhelming and we can see patterns from history which might give us a clue as to where we stand today, what might happen next and who the big winners might be. It should be fairly obvious to investors today that we are in the middle of a very strong, AI-driven cycle for IT hardware as the infrastructure for an AI based platform of computing is being developed at a rapid pace. Yet, obvious questions remain, such as "how long will this last?" and "are we once again overestimating the short-term significance and underestimating the long term impact?" To put this in context, it might be useful to look at previous hardware cycles and their characteristics as the various computing platforms have evolved over the last 60 years or so. Chart 1: The evolution of computing platforms Source: Jeffries Equity Research Chart 1 above shows the evolution of computing platforms since the 1950s. We can see that each era lasts around 10 to 15 years and with each passing cycle, the number of devices connected to the network has increased tenfold. As a result, technology has penetrated more and more industries and been applied to more and more aspects of everyday life. What is less clear from the chart is that in each era, there has been one or two companies that have typically captured 80% or more of the hardware value chain. IBM in the mainframe era, DEC in mini-computers, Microsoft /Intel in PCs, Nokia and then Apple in cell phones and so far Nvidia in the parallel processing/IoT era powered by an AI datacentre at its core. It's probably fair to assume that we are likely in the early stages of the AI-related infrastructure build, perhaps at a point equivalent to the mid-1990s when the internet was still being constructed. While this rapid growth phase for hardware is likely to slow down, there is still a long runway of adoption to go if prior cycles are any guide. One significant difference between the AI infrastructure boom and the growth in fixed and mobile internet infrastructure is the fact that the internet rollout was largely financed by debt raised by telecom companies and IPOs raised by often loss-making early stage companies. Today's AI infrastructure, however, is being built using cash flows from large and very profitable businesses. This factor alone may give the hardware cycle more longevity than its predecessors. In terms of applications and profitable use cases for AI, it appears that we are in a position similar to the mid-to-late 1990s when the internet was being developed. Back then, we expected navigation, entertainment and e-commerce would likely become the main applications for the internet. It took a further decade for the smartphone to reach the mass market and fully enable the potential of the network, allowing companies like Apple, Meta Platforms, Alphabet, Amazon and others to flourish. AI may yet be applied to new industries and revolutionise the competitive landscapes therein. Drug discovery, self-driving cars, media content production and software code writing could all become the main applications for AI in the longer term. However, it is too early to make definitive predictions. The emerging risk of a classic hype cycle seems fairly clear. If profitable use cases are not delivered soon enough, this may slow the infrastructure boom. This was certainly the case in the late 1990s early 2000s. However, back then the internet infrastructure collapsed under an unsustainable mountain of debt, which was paid out in the form of expensive 3G licences. During this period, Apple disrupted the telecom value chain with the power of iTunes and then the smartphone. This time, the spending is funded by cash flow and earnings, and while it may slow down, it seems unlikely to collapse any time soon. In conclusion, the impact of AI clearly has the scope to be far-reaching and is likely a factor investors will have to contend with for a long time to come. Q2: Will the market leadership broaden beyond technology names into other sectors? The possibility of stock market leadership broadening beyond technology names and into other sectors, in our view, depends on several factors. These include economic conditions, the level of real rates, sector-specific earnings, cash flow developments and investor sentiment. In general, market leadership so far in 2024 has been driven by upgrades in earnings and cashflow. Five mega-cap AI stocks--Nvidia, Alphabet, Amazon, Meta and Microsoft--have accounted for almost all of the market's return. However, value stocks in areas such as energy, banking and insurance have also performed well, while defensives such as consumer staples and healthcare have largely underperformed. The market seems to be assuming that we are in the middle of a business cycle of indeterminate length--all underpinned by a gradual disinflationary environment. It is only natural to question if this is a fair assessment. Does it all add up? How should we construct portfolios in this environment? So far in 2024, changes in earnings have had a greater influence on the market than changes in real interest rates (Chart 2). The chart shows how much of the returns can be explained by changes in earnings. Rather ominously, similarly high readings were seen just before major market events, such as the Asian financial crisis of 1998, the dot.com bust of 2000, and arguably, the Global Financial Crisis (GFC) of 2007/2008 and the European debt crisis of 2012. Chart 2: Proportion of S&P 500's large-cap stock returns attributable to changes in earnings Large capitalisation stocks' share of the return dispersion explained by the dispersion in earnings surprise measured over nine-month windows from 1993 through mid-May 2024. Past performance is not indicative of future performance. Source: Empirical Research Partners Naturally, investors are wondering if there is something equally damaging around the corner which may cause this benign central scenario to unravel. If we examine each factor, listed below, we may be able to draw some conclusions. Sustainability of the AI boom and technology valuations As mentioned in the answer to the previous question, we are still relatively early in the roll out of the next generation of a global computing platform with AI data-centres at its core. Given that the capital expenditure is largely being funded via cash flow and operating earnings, there doesn't seem to be a reason for the spending to come to a juddering halt any time soon. There may be disappointment over the lack of profitable applications (similar to the experience during the internet boom), which may cool investor sentiment. However, so far, the improvements in earnings and cash flow appear sustainable and are certainly far more attractive than those being produced by many other parts of the economy. Is the disinflationary consensus appropriate? It's been over four years since the pandemic stopped the global economy in its tracks. The unprecedented economic standstill and the incredible degree of stimulus that supported the recovery meant that these circumstances were truly unique. But is this still the case? There are clear signs that we are approaching a new normal. The US labour market is coming back into balance following the large-scale retirements of baby boomers during the pandemic and low immigration levels, which led to the tightest labour conditions since World War 2. Now, a recovery in net migration and higher female labour participation has brought the jobs market into balance, leading to a cooling of wage inflation. In addition to a modest cooling in labour conditions, the shelter component of the CPI is also beginning to moderate. The increase in mortgage rates has caused homeowners in the US to stay put, as moving could result in mortgages being repriced to unaffordable levels. This has dramatically cut the supply of single-family homes in the market. However, the number of apartments under construction is now at highs not seen since the 1970s; vacancy rates are normalising, suggesting the pressure on the CPI from the shelter component should continue to ease. The relative health of the jobs market has also helped offset the drawdown in consumers' excess savings, which are now nearly exhausted. Despite the rapid tightening in monetary policy by the Federal Reserve, consumers, in general, have remained in reasonable shape. Conditions have undoubtedly been tough for those in the lowest parts of the income distribution, but even here, wage growth is at least keeping pace with inflation in necessities and debt service costs. In addition, consumers in the top quintile of the income distribution, who account for nearly 40% of all spending, actually benefit from higher rates. What are the prospects for other sectors? If our central scenario suggests that we are in the middle of a cycle where corporate earnings power is beginning to accelerate as the economy achieves a soft landing, then we must consider the prospects for other sectors and the longer-term level of real interest rates when we think about these opportunities. Given the context of challenging geopolitical conditions, trade barriers and the prospect of a heavy supply of US Treasuries (USTs), it may be prudent to assume that the level of real rates should be higher in the next decade than it has been for the last 10 years. If this is the case, then the prospect for cyclical value sectors could be quite positive, provided that credit quality remains strong. Banks, insurers, some industrials and potentially energy sectors could see their earnings prospects fare relatively well in this scenario. Given the compelling valuation starting point, earnings upgrades for these industries could be accompanied by rising share prices. If this were to occur during a slowdown in the AI boom, these industries could take the lead in the market. But what about defensives? In 2024, sectors historically correlated with the fortunes of the bond market have proven something of a disaster as their yield advantage has been eroded. The valuations of these sectors, such as consumer staples and healthcare, are now arguably reaching levels where the risk-reward looks very attractive. For this to bear fruit however, we need a major dislocation in the market from a growth perspective and for the economy to endure a hard landing. This seems unlikely today but given the tense state of geopolitics and the major election cycle currently taking place, the benefits of diversification should not be underestimated over the longer term. Q3: What are the main risks and challenges equity investors may face in the remainder of 2024? Whether it's about the level of the CPI, the direction of economic growth, credit quality in the consumer and corporate sector, the housing market, supply of USTs, elections, geopolitics or even an outright stock market bubble, the list of investor worries and concerns seems as long as one can remember. Yet the market continues to push higher. Are we headed for a fall or are we in an economic sweet spot with moderate growth and declining inflation that could go on for some time? Like any journey, to really understand the benefits of the destination, we should also understand our starting point. Taking a long-term view makes this a little more straightforward and likely helps us draw some better insights, given the myriad of potential outcomes which exist in the short-term. The last 15 years have been characterised by unprecedented fiscal and monetary stimulus to keep the cost of money low following the GFC and more recently to support economies during the pandemic. The low cost of capital reached a pinnacle in a 2021 stock market bubble of money-losing growth stocks, which burst spectacularly as the cost of money increased. The next 15 years seem unlikely to be a repeat of the last 15, with the direction of real rates being the primary concern for investors. Our best guess is that we are now faced with a sustainably higher cost of capital than the abnormally low level we witnessed following the GFC. A number of factors contribute to this, including (but not limited to) the high forthcoming supply of government debt to fund a burgeoning fiscal deficit, the impact of geopolitics on trade restrictions and the inflationary implications of the energy transition. If real rates are indeed set to rise over the next decade or so, this will have implications for stock picking as immediate profits become more valuable to investors than the hope of potential profit a decade from now. This might explain why the companies in the market related to the AI theme are performing so well, as they are also experiencing sharp increases in earnings and cash flow. This contrasts sharply with long-duration growth stocks, which continue to lag the market as the anticipated earnings for 2035 or beyond remain just that--hope. Yet, perhaps the biggest risk to investors with time horizons of 10 years or more is missing out on the opportunities a well-diversified portfolio of global equities can offer. As a smart investor once said, "time in the market is far more important than timing the market". This seems as true today as ever. We are on the verge of a further breakthrough in productivity, enabled by the ongoing evolution of computing platforms, and we stand ready to tackle arguably the most pressing challenge in human history--climate change. Throughout history, equity investors have benefitted from maintaining a long-term view and an optimistic outlook on humanity's ability to prevail in the face of adversity. This might once again be the case, meaning that the biggest risk might be not having exposure to the highest quality earnings streams through a diversified portfolio of global equities. Perhaps we have already mentioned that we know professionals who can be of assistance in such matters. Global Equity strategy composite performance to June 2024 Funds operated by this manager: Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund Important disclaimer information Please note that much of the content which appears on this page is intended for the use of professional investors only.   Past performance is not a guide to future returns. *The benchmark for this composite is MSCI ACWI Net Total Return Index. The benchmark was the MSCI ACWI ex AU since inception of the composite to 31 March 2016. Inception date for the composite is 01 October 2014. Returns are based on Nikko AM's (hereafter referred to as the "Firm") Global Equity Strategy Composite returns. Returns for periods in excess of 1 year are annualised. The Firm claims compliance with the Global Investment Performance Standards (GIPS ®) and has prepared and presented this report in compliance with the GIPS. GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. Returns are US Dollar based and are calculated gross of advisory and management fees, custodial fees and withholding taxes, but are net of transaction costs and include reinvestment of dividends and interest. Copyright © MSCI Inc. The copyright and intellectual rights to the index displayed above are the sole property of the index provider. Any comparison to a reference index or benchmark may have material inherent limitations and therefore should not be relied upon. To obtain a GIPS Composite Report, please contact [email protected]. Data as of 30 June 2024.

Global Investment Committee review: still positive, with downside risk caveats Nikko Asset Management August 2024 On 13 August, the Global Investment Committee (GIC) held an extraordinary session to review the impact of recent volatile market movements, as well as the growing concerns over slower US growth. In summary, our conclusions were as follows: We maintain our central scenario for positive GDP growth in most major economies, although we see heightened downside risks to our US GDP growth outlook given recent softer-than-anticipated US data. We continue to anticipate range-bound inflation, with a gradual disinflationary trend in the US and Europe. Meanwhile, we expect reflation to continue in Japan and pick up in China. We continue to see the Federal Reserve (Fed) as likely to deliver at least one interest rate cut in 2024, which we believe will help growth remain positive. However, we also foresee higher risks of a more pronounced slowdown in growth; this, in turn, could contribute to higher risks of the Fed engaging in multiple rate cuts in 2024 and early 2025. We maintain our view that Japan's "virtuous circle" of wages and prices will remain intact, with growth likely to remain above potential and inflation expected to surpass the Bank of Japan (BOJ)'s 2% target over the immediate horizon. The yen, meanwhile, recouped some of its earlier losses faster than we expected. Combined with our outlook for upcoming Fed rate cuts, the BOJ's resolve to normalise policy (albeit gradually) is likely to keep the yen moderately supported. Indeed, versus the dollar, we do not foresee the yen spending time back above 150. This may, in turn, bring some temporary volatility that impacts equity valuations, which could create buying opportunities. Meanwhile, there is some risk that the yen's reversal may have some second-round effects on corporate earnings, albeit with a lag. We expect US earnings growth to remain positive over our outlook period but maintain our more conservative earnings outlook versus consensus estimates. Moreover, we foresee limited upside in valuation (P/E), unlike in Japan where valuations are less rich. Global macro: increased downside risks to US GDP growth outlook New developments in US GDP growth and inflation since Q2: In the US, following several substantial downward revisions to past data, the July nonfarm payrolls came in significantly softer than expected. The US unemployment rate also rose to 4.3% (although, importantly, labour participation rose). The Sahm rule1 was triggered, and some market participants began to fear that a recession was imminent, giving rise to some calls for 50 basis point (bp) Fed rate cuts within 2024. June's core CPI cooled further while US manufacturing activity contracted in July by the most in eight months, weighed by subdued orders and production in addition to the largest ISM employment drop in four years. However, there were also caveats to the weak data. Although consumer sentiment remains soft, average weekly earnings continued to expand in June, as did retail sales. Meanwhile, despite the softer June CPI print, the Fed's favoured core PCE indicator failed to decelerate as expected in June. Additionally, in spite of disclaimers by the Bureau of Labor Statistics that the weather (hurricane Beryl) had "no discernible effect" on the weak nonfarm payroll figure, the data appear to indicate otherwise. Most of the layoffs were temporary (with permanent job losses little changed) and the decline in job losses in the establishment survey was concentrated in transit and ground passenger transportation sectors, which were likely to have been influenced by the weather. Moreover, the increase in the US unemployment rate comes amid steady growth in the US labour force (thanks to immigration) and a steadily increasing labour participation rate. As such, this decrease does not owe purely to a deterioration in employment. GIC perspective: slower but positive growth trajectory intact while volatility contributes to downside risks With inflation, though showing some signals of slowing, still above the Fed's 2% target, we were reluctant to react to one month of soft US data. Meanwhile, several Fed speakers have since tempered expectations for aggressive easing, including multiple 50-bp reductions or inter-meeting cuts. That said, we note the reaction of financial markets to the softer data with the VIX spiking to highs above 60 as speculative "carry trades" were unwound. While we admit that it may be somewhat circular to reference financial market turbulence as a harbinger of slower growth, it is worth noting that financial markets have been great contributors to accommodative financial and monetary conditions. As such, we found it unwise to overlook downside risks to the economy should financial market volatility return and prove disruptive to growth. Therefore, we have downgraded our 25th percentile US growth estimates as outlined below, which also slightly impacts the median GIC estimates of US growth. Central bank rates and forex: yen unlikely to revisit lows; downside risks to FOMC New developments in central bank rates and forex since Q2: The BOJ surprised many market participants by hiking interest rates to 25 bps on 31 July. The BOJ's statement signalled upside risks to prices and a modest upgrade to the upper end of longer-term core inflation within the quarterly Outlook for Economic Activity and Prices. The BOJ meeting was soon followed by the July FOMC and Chair Jerome Powell's statement cemented expectations for a September rate cut. We should note that Powell, who signalled that a rate cut could come "as soon as" September, also did not rule out the possibility of "zero cuts" and indicated that any easing would depend on data. Dollar/yen meanwhile showed somewhat of a muted reaction to the 31 July BOJ decision. The market was subdued until the 2 August release of the US July nonfarm payrolls, which surprised on the downside. Subsequently, the BOJ's summary of opinions released on 8 August made a reference to a terminal interest rate of "at least" 1% (largely reflecting rising long-term inflation expectations) and was therefore perceived as hawkish. The US data disappointment combined with the BOJ's perceived hawkish stance helped to trigger a succession of events in financial markets. Large speculative yen shorts crumbled as US recession fears prompted some market speculation that the Fed was "behind the curve" or that the BOJ would engage in a series of rate hikes without ensuring that markets would successfully absorb them. Volatility has since abated somewhat, but what remains clear is that relative interest rate differentials (of late, real interest rate differentials) have been driving the carry trade. As a result, even a small narrowing of the spread caused leveraged players to bow out. Subsequent to the resurgent market volatility, BOJ Deputy Governor Shinichi Uchida offered assurance that further rate hikes would not come amid unstable markets, and with many speculative yen shorts liquidated (at least, according to the IMM Commitment of Traders report), dollar/yen stabilised above the 145 level (modestly above Japanese corporates' FY-end expectations per the BOJ's July Tankan report). That said, many current estimates of purchasing power parity puts 1 dollar at slightly less than 100 yen, which implies that "fair value" may exercise a downward pull on the currency pair given the outlook for gradually narrowing interest rate differentials. GIC perspective: dollar/yen to remain range-bound with limited downside to Q2 2025 With speculative yen shorts apparently largely cleared after building up to multi-year highs, we feel that there is limited impetus for dollar/yen to resume its sharp drop in the near term. The BOJ has been duly warned by currency volatility and it has committed itself to making its next move in calmer markets. We maintain that BOJ policy, still accommodative by most measures, will likely tighten at some point. However, we believe that there is sufficient reason for the BOJ to continue to gauge not only data (which has been positive of late, such as buoyant private demand-fuelled Q2 GDP growth and positive June real wage growth) but also overseas data and financial market conditions. We therefore maintain our BOJ outlook (we had foreseen one rate hike from the BOJ sometime between July and September) although we modestly downgraded our dollar/yen and euro/yen guidance ranges. Meanwhile, the heightened downside risks that we see to US GDP growth also correspond to higher downside risks to Fed policy rates, as follows: Japan equities: volatility, dollar yen impact temporary but non-negligible New developments in Japanese equities since Q2: As the market re-rated the "carry trade", the CBOE VIX index (a proxy for equity market risk over the next 30 days) spiked on 5 August to above 60 from below 20, after which volatility has slowly abated. The Nikkei 225, which is price-weighted and therefore volatile, saw three-month at-the-money implied volatilities (a slightly longer horizon measure than the VIX) surge above 37 on 5 August before slowly pulling back. The TOPIX, typically less volatile, also saw three-month at-the-money implied volatilities spike near 30 and then ease somewhat. Japanese stocks were oversold (with TOPIX price/earnings ratios sinking to the mid-11 handle), and the decline became a good opportunity for companies to buy back shares and institutional investors to accumulate stock. The TOPIX index subsequently staged a comeback, with price/earnings recovering to 15. Early observations by sector: Financials and trading company stocks were the hardest hit amid the sell-off but domestic demand and defensive names (e.g. medical equipment) remained more resilient. Similarly, many cash-rich stocks, as well as firms investing in human capital and consequently experiencing increased productivity, have also remained robust. Meanwhile, the sell-off significantly affected semiconductor and auto stocks. The sell-off may have undervalued high dividend yield names, which could be poised for an eventual comeback. GIC perspective: With volatility still higher than before the recent market shock, the rebound by Japanese stocks appears to be limited below prior highs. That said, earnings in the first quarter of Japan's current fiscal year (FY24) appear solid so far. Signals of domestic demand, including both consumption and investment, becoming a stronger driver of growth continue to support Japan's "virtuous circle". Firms appear to retain pricing power even as real wage growth has turned positive. The outlook appears structurally sound for the longer-term, though near-term, we suspect that the impact of stock volatility as well as a stronger yen (which would impact firms with significant overseas revenue) may exercise an interim drag on earnings in some sectors. Although we remain positive on earnings growth overall, it is possible that we may see some sector rotation, allowing for domestic demand sensitive firms that have underperformed to date to catch up with those more driven by overseas revenues. We continue to expect Japanese corporates to generate healthy single-digit earnings growth across the TOPIX, which represents the majority of our Japan equity investments. However, we foresee valuations being affected by potential ripple effects from the recent market volatility and carry trade unwinding. We estimate that the impact may last for three to six months. Additionally, there is a risk that a weaker dollar/yen could, with a lag, exert a downward pull on the earnings of large cap exporters with overseas revenues, particularly among Nikkei constituents. Although we remain firm in our conviction that Japan's structural recovery is likely to continue supporting Japanese equities, we acknowledge the possibility for an interim resurgence in equity volatility. The GIC is shifting from single valuation assumptions (P/E) in Japanese stocks to a guidance range for P/E. This is similar to our guidance range for earnings per share (EPS) guidance, with which we aim to capture probabilities between the 25th and 75th percentiles of consolidated earnings growth. We are also making modest adjustments to our EPS guidance ranges and adding 25th and 75th percentile indicators for Nikkei-listed large-caps. Earnings guidance ranges: We foresee year-on-year (YoY) earnings growth for the TOPIX ranging between 3% and 8% YoY (excluding base effects adjustments) over the second half of 2024. We expect earnings growth to recover to between 4% and 11% in the first half of 2025, once near-term volatility abates and companies have adjusted to a mildly stronger yen. We foresee the Nikkei's earnings range between 5% and 20% YoY for H2 2024 (excluding base effects adjustments) and between 5% and 19% over the first half of 2025, with a more lasting impact likely to be felt among large exporters and firms reliant on substantial overseas revenue. In the near-term, we anticipate an adjustment in YoY EPS growth in September, due mostly to the low base effects of September 2023's EPS. We believe that in the September quarter of 2024 there will be a one-off adjustment in YoY EPS growth terms in order for annual EPS to be kept on a gradually increasing trajectory. EPS growth guidance Valuation ranges: We expect price/earnings to show greater fluctuations than what we have observed very recently. This is due to the market appearing more vulnerable to swings as uncertainty over economic growth impacts markets. We are therefore expanding our P/E estimates from single assumptions to a range, estimating outcomes between the 25th to 75th percentile. We expect the Nikkei's P/E range to fluctuate between 16 and 24 in H2 2024, followed by a range of between 16 and 25 in H1 2025. We anticipate an upward bias over time given ongoing structural transformation among Japan's corporates, led by large caps. For the TOPIX, we foresee a range of 13-17x in H2 2024 and 13-19x in H1 2025, with a similar upward trend over time. P/E ratio guidance Implied price (indicative only): price trends to be driven by EPS and higher valuation over time As we noted in our Q2 GIC Outlook, we have made changes to the GIC process. This includes more closely aligning our Outlook with the views underlying our portfolio investments and therefore providing indicative guidance ranges as opposed to point forecasts of index prices for indicators and indices. As a result, we have shifted to guidance centred on variables that are of interest to us as investors, including earnings growth and valuation. For the convenience of our readership, we calculate indicative prices as implied by our EPS growth (using Bloomberg's "BEst" Earnings estimates of realised earnings per share for the base year) and price/earnings guidance ranges, for reference purposes only. Based on the guidance provided above, the implied index prices are as follows: Implied price (using 2023-2024 BEst EPS as base) The lows within the range represent the lower end of our anticipated price fluctuations, which takes into account the combined effect of earnings impact and valuation shifts. The highs within the range represent the upper end of our anticipated price fluctuations. Appendix 1: GIC outlook guidance revisions Global macro Central bank rates, forex, fixed income and commodities Equities Funds operated by this manager: Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund Important disclaimer information Please note that much of the content which appears on this page is intended for the use of professional investors only. 1 The Sahm rule is a heuristic measure of determining whether the economy has entered a recession using unemployment relative to recent history. The Sahm rule compares the three-month moving average of the national unemployment rate to its low over the prior twelve months (with an indicative threshold of 0.5% above the prior 12-month low).