Financial markets are going through a particularly interesting period.
Despite the conflict in the Middle East, equities are reaching or approaching all-time highs. At the same time, bond markets are struggling.
How can this dichotomy be explained?
Equities Remain Buoyant
Equity markets clearly seem eager to move past the conflict in the Middle East and resume their upward momentum. Although the conflict is not over and the risk of the ceasefire period ending remains very real, many markets have reached, or come close to, historical highs. There are several reasons behind this rise.
Despite all the threats weighing on the economy and global trade, corporate earnings have been relatively encouraging, underlining companies' resilience in a difficult environment.
And while households are not exactly in a celebratory mood, they still have the means to spend for now. Tight labour markets across much of the West are clearly contributing to this.
After the post-pandemic period, when purchasing power fell sharply as wages grew more slowly than inflation, the trend has reversed. Even in the Eurozone, purchasing power has slightly increased since 2024.
Oil barrel at USD 90 is the new normal
Are equity markets, therefore, too optimistic about the outcome of the conflict in the Middle East? Not necessarily. Indeed, they are not pricing in a resumption of fighting or a widening of the conflict to other actors, which would sustain oil prices above USD 100 per barrel.
But they would cope reasonably well with a messy exit from the conflict, and even with possible passage fees through the Strait. Given that Donald Trump is keen to bring the matter to an end, with midterm elections due in six months, on 3 November, markets see such an outcome as the most likely. And given that the US President has already changed his mind several times when his personal fate or that of the stock market was at stake, it is difficult to say they are wrong.
Investors also believe that the world has already lived with oil at around USD 80–90 per barrel and that the global economy will be able to adapt, either by adjusting oil demand and/or diversifying sources of supply.
Such a scenario would certainly not be the most supportive, but it would restore some visibility for companies and allow the economic machine to restart on somewhat firmer foundations.
Bond Markets Remain Under Pressure
While equity markets see reasons for optimism, the bond market appears much more downbeat. Should this be seen as excessive pessimism? Higher interest rates are indeed weighing heavily on bonds, many of which have posted losses since the start of the year. But this caution has not come out of nowhere.
When an investor buys a bond, they essentially expect two things. First, a yield sufficient to compensate for rising prices, meaning inflation.
Second, a level of remuneration that reflects the risk taken, whether linked to the issuer's creditworthiness or the currency in which the bond is denominated.
The current conflict complicates matters on both fronts. The sharp rise in oil prices (around 60% since the beginning of the year) is already pushing inflation higher. Even if energy prices stabilise, they will probably force authorities to revise their inflation forecasts upwards and tighten monetary policy, particularly through rate hikes. This is especially true in the Eurozone, where the European Central Bank remains highly vigilant.
A matter of trust
In this context, it is logical for investors to demand higher yields to lend to governments or companies. This is all the more true as debt continues to rise almost everywhere.
The restoration of public finances, often postponed, remains largely theoretical in many developed countries, and the current conflict could further aggravate the situation. The United Kingdom and France, for example, are viewed with increasing caution, while in the United States, Donald Trump's policies are also raising concerns.
As a result, many debt issuers are considered less reliable than before. And because the amounts to be financed are enormous, competition between issuers is stronger, pushing them to offer more attractive yields to appeal to investors. In such an environment, it is difficult to imagine a rapid decline in bond interest rates.
It is therefore understandable that investors are now demanding better remuneration to invest in bonds. The real question is whether current yields are sufficient to convince them.
In our view, the answer is yes, particularly in the United States. The yield on 10-year US debt, at around 4.3%, is well above the dividend yield on equities. The gap exceeds 3%, a level far above its average over the past 20 years. At these levels, adding broad bond exposure to a portfolio is not a sacrifice. Quite the opposite, it remains a genuine diversification opportunity.
Portfolio diversification remains a critical strategy
Should either the equity market or the bond market be considered wrong in the current environment? We do not think so. Equity markets, especially those less exposed to the conflict, such as the United States, Poland, or Latin America, have good reasons to remain confident and avoid worst-case scenarios. At the same time, the bond market is correctly capturing the inflationary threat and the gradual deterioration in credit quality, and is adjusting the yields it demands.
These two realities should be viewed in the context of bond yields standing at historically high levels relative to the dividends offered by US companies. In such an environment, proper portfolio diversification is not only important for risk reduction but also for yield-seeking. As a result, although we maintain exposure to equity markets that we consider promising, we are not neglecting the role of US bonds within our asset allocation strategies.
A diversified and well-balanced portfolio in Optimize Invest Selection
Currently above 3%, the gap between the yield on US bonds and the dividend yield of US equities is at its highest level in more than 20 years. At such levels, US bonds appear attractive to us; they are among our picks for funds like Optimize Invest Selection.
This is a balanced fund composed of both equities and bonds, advised by Euroconsumers Invest during 2025.
Despite the uncertainty in the markets over the past year and more recently, the Optimize Invest Selection has shown resilience and a favourable risk-reward ratio, making it an interesting option for those looking for a diversified, well-balanced investment portfolio. The fund characteristics, terms and conditions, and the factsheet are available at https://optimize.pt/en/investment-funds/invest-selection/.