Market Review 19th October 2026
Everything you need to know, Simplified!
A wake-up call for AI and the future of the 60/40 portfolio
Summary
In a week when most individual stocks delivered a positive return, semiconductor and other AI-related shares fell sharply; semiconductor stocks fell more than 15% over eight consecutive sessions; the rout reflects concerns over the sustainability of artificial intelligence (AI) spending, intensifying Chinese competition and stretched valuations against a backdrop of rising interest rates.
US Treasuries (government bonds) provided a meaningful diversification offset despite the inflationary backdrop, with the AI-driven growth scare fuelling a flight-to-safety bid that supported bonds even as hotter-than-expected US inflation data reinforced expectations for further Federal Reserve rate hikes
Energy markets dominated headlines as Brent crude oil hit US$110 a barrel for the first time since May, closing the week up 4.9% at US$109.86, while WTI oil topped US$100 for the first time in weeks; the move was driven by intensifying Middle East conflict, with Iran-backed Houthi rebels striking oil company Saudi Aramco's headquarters and ongoing Iranian attacks on tankers in the Strait of Hormuz threatening supply flows; an International Energy Agency pledge to release 100 million barrels of emergency reserves offered only brief relief, with bullish sentiment prevailing into the weekend.
Market Review
When the chips are down, bonds step up
Since 2022, many market strategists have questioned the diversification potential of bonds - to what extent can they be relied upon to cushion equities during a drawdown? For most of the preceding forty years, multi-asset investors could simply count on a consistent, negative stock-bond correlation as a structural feature of balanced portfolios. Since 2022, however, inflation has induced a more dynamic and persistently positive stock-bond correlation. In short, bonds have repeatedly failed to diversify equity risk - and many strategists even wrote the obituary of the 60/40 portfolio.
We have increasingly viewed the rise in yields as an opportunity, particularly over recent months, as the move higher has been concentrated in real yields rather than inflation expectations. Bond yields can be decomposed into two components: expected inflation and the real yield - the additional return investors demand above that inflation expectation. In the US, it is the real yield component that has expanded materially, with 10-year real yields approaching 20-year highs near 3.0%, while inflation expectations have remained contained.
Rising real yields reflect an economy competing intensely for capital, consistent with our view that surging AI-driven spending demand from hyperscalers has been an important force pushing real rates higher, rather than a renewed rise in inflation fears. Hedge fund Citadel made a similar observation, noting that all of September's increase in 10-year yields came from real yields, with inflation expectations remaining stable. For bond investors, this is a more constructive backdrop than a generalised inflation shock - real yields at these levels offer genuine compensation.
The sharp sell-off in AI-related stocks towards the end of last week saw the traditional diversification return in striking fashion. Even as Wednesday's hotter-than-expected CPI print sent two-year yields surging more than 15 basis points (bps) to 4.95%, Treasuries subsequently reversed sharply. The 10-year yield closed the week at 5.07%, a full 25bps below Wednesday’s post inflation peak as the AI growth scare overwhelmed the inflation signal.
This dynamic presents a meaningful shift in risk sentiment: last week it was equities, not inflation, driving bond markets. Bonds acted as a genuine hedge to the week's equity volatility - precisely the role they have struggled to play since 2022.
Whether this marks a temporary reprieve will depend on whether the next leg of market stress is driven by growth or inflation fears. For now, the evidence suggests bonds have earned back their place in the diversifier's toolkit.
The week ahead
UK inflation
Due on Wednesday, UK inflation is anticipated to accelerate to 3.4%, driven predominantly by energy costs. Economists also predict a mild pick-up in core inflation as the passthrough of higher energy costs feeds through into the broader CPI basket. To date there is little evidence of strong pass-through inflation and wage growth remains steady. Inflation is expected to continue to rise, peaking at a little over 4% in the first quarter of next year.
S&P Global PMIs
Due on Friday, S&P Global’s October surveys are expected to show a global economy still expanding across both services and manufacturing, with the US remaining the principal engine of growth.
In the UK, both manufacturing and services have held comfortably in expansion territory with much the same expected for October. France’s October readings will be watched closely given the worst civil unrest France has seen in years raising questions over whether consumer and business confidence will take a hit.
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