History shows that while unexpected wars and military conflicts, such as those occurring in the Middle East, inevitably cause volatility and collapse in values across most market sectors on Wall Street in the short term, the long-term trajectory of the market is rarely impacted for long. Remember the adage, in the short term the market is a voting machine, but in the long term it is a weighing machine, i.e. value will prevail over emotion over time – Ash-Ridge Market View 2^nd Quarter Forward Outlook

LAST QUARTER REVIEW

Following Wall Street’s dramatic setback during the first quarter in response to the Middle East conflict between the United States and Iran, the S&P 500 rose to a new record close of 7609.78 on the 2^nd June. This represented a rise of 19.96% from its Middle East conflict low of 6343.72 on the 30^th March and once again proved the historical narrative referred to above which favours the investors who stay focused on the big picture and ignore periodic market noise.

At its June meeting of the Federal Open Markets Committee (FOMC), the Fed left its federal funds rate unchanged at 3.5% – 3.75% for a fourth consecutive month as expected. Out of the 19 policymakers who make up the board however, 9 expect rates to be increased once during 2026, whilst 6 are projecting two interest rate hikes before year end. Following the impact of the Middle East conflict, the Fed is now forecasting GDP growth this year lower at 2.2% (previously 2.4%) – the 2027 forecast remains at 2.7%

The Fed revised PCE inflation sharply higher to 3.6% from 2.7% for this year and from 2.7% to 3.3% for 2027. Policymakers noted that economic activity is expanding at a solid pace despite inflation exceeding the 2% target and the elevated uncertainty that owes, in part, to the conflict in the Middle East.

As we noted last quarter Bond markets appear to remain concerned about potential inflation as the yield on the benchmark 10-year US Treasury Note is little changed during the quarter at 4.43%, but arguably this is not a true reflection of future expectations as we observe later in this MV. The Nasdaq 100 and the Dow Jones Industrial Index also registered new record highs in early June with former rising an extraordinary 33.58% and the latter 15.89% from the conflict lows of March.

The US dollar has fluctuated during the last quarter but following the June FOMC meeting rose again through 100 when measured against the DXY, a basket of other currencies weighted on market size. Gold on the other hand which had, prior to the conflict, risen to almost $5500 continued to struggle falling more than 14% during the last quarter.

In the UK, the Bank of England (BoE) voted to keep the Bank Rate at 3.75% in June 2026, as policymakers weighed easing inflation against continued uncertainty from volatile global energy markets linked to Middle East tensions, with 2 members of the Monetary Policy Committee (MPC) voting to raise interest rates by 0.25%. Officials said global energy prices have declined since the previous meeting following developments in the Middle East but remain elevated and unstable compared with pre-conflict levels.

While UK CPI inflation has eased to 2.8%, the BOE expects it could rise later this year as earlier energy increases continue to feed through. However, it is a mixed picture as the labour market is showing signs of cooling, and broader economic momentum appears to be weakening, which could help limit inflationary pressure

During the quarter, the UK’s benchmark 10-year gilt yield once again surged through 5%, the highest since July 2008, before settling quarter end at 4.86%. The FTSE 100 (made up primarily of globally focused companies with international earnings) rose modestly 3.15% during the quarter, while the domestically focused FTSE 250 and FTSE SmallCap indices rose almost 9% and 10% respectively reflecting confidence in the strength of the UK economy

In the Eurozone, the European Central Bank (ECB) raised interest rates by 25 basis points at its June 2026 meeting, the first increase since 2023, as it remains focused on anchoring inflation at the 2% medium-term target, despite rising energy costs and persistent inflation risks driven by the disruption to oil shipments through the Strait of Hormuz.

Due to the conflict, the ECB has revised down growth projections in 2026 from 1.2% to 0.9% and from 1.4% to 1.3% in 2027, with 2028 unchanged at 1.4%, while inflation is expected to average 2.6% (previous 1.9%) in 2026, 2.0% (1.8%) in 2027 and 2.1% (2%) in 2028. The ECB has revised its inflation forecasts upward, anticipating headline inflation of 3.0% in 2026 (up from 2.6%) and 2.3% in 2027 (2.0%), while core inflation was revised to 2.5% for both 2026 (2.3%) and 2027 (2.2%).

The People’s Bank of China (PBOC) kept key lending rates at record lows for a tenth consecutive month in March, in line with market expectations, with the one-year Loan Prime Rate (LPR), the benchmark for most corporate and household borrowing at 3.0%, while the five-year LPR, which anchors mortgage rates, held at 3.5%. The cautious stance reflects surging oil prices and Middle East tensions clouding the inflation outlook, alongside Beijing’s lower 2026 growth target of 4.5% – 5%, its weakest since 1991, reducing the urgency for broad easing.

In line with market Expectations, the Bank of Japan (BoJ) raised its key short-term rate by 0.25% to 1.0% at its June meeting, the first hike since December and marking the highest level since September 1995. The BOJ noted that financial conditions would stay accommodative despite the rate hike, continuing to support economic activity, and it will continue raising rates as warranted by economic, price, and financial developments, while closely monitoring the Middle East conflict’s impact on the economy.

Crude oil collapsed to below $70 a barrel, its largest quarterly decline since 2020, and reaching its lowest level since late February (after peaking at almost £115 during the crisis), as increasing tanker traffic through the Strait of Hormuz and progress in US-Iran peace talks eased supply fears with shipowners confidently transiting the chokepoint with active satellite signals following safety guarantees from the International Maritime Organization. Additionally, the International Energy Agency (IEA) estimates the United Arab Emirates has almost doubled pre-war output selling roughly 60 million barrels from the Persian Gulf recently, which overshadowed US data from the Energy Information Administration (EIA) showing US crude inventories at their lowest since 1984.

GDP Data shown are to the 31st of March 2026; Interest Rate, Equity & Sovereign Benchmark Bond Yield Data are to the 30^th of June 2026; Equity Indices used: US – S&P 500, UK – FTSE 100, Eurozone – Euro Stoxx 50, China – Shanghai Shenzhen CSI 300, Japan – Nikkei 225, Germany – Xetra Dax; Benchmark Sovereign Bond Yield Data courtesy of Trading Economics.

CURRENT CONSIDERATIONS

As the Federal Reserve begins a new era under incoming Chair Kevin Warsh, investors will be focused on any changes in interest rate policy. CNBC noted that, “Warsh has been promising to shake things up at the Fed, and his first steps in doing so came when he announced the formation of five task forces, charged with studying communication, the Fed’s balance sheet, the data sources on which it relies, productivity and jobs, the impact of artificial intelligence and other transformative technologies, and the central bank’s inflation approach.”

Naturally, with the Middle East conflict between the US and Iran seemingly moving to a peaceful settlement and oil beginning to flow more freely through The Strait of Hormuz, investors will be hoping the threat of US interest rates increasing will recede and the focus will once more turn to reducing them as was the case pre-conflict. However, despite the benchmark S&P 500 rising almost 15% during since March 31^st (its strongest quarterly gain in 6 years), investors continue to ponder whether we are in a new inflationary / reflationary environment or simply experiencing a brief respite from the deflationary trend that has held sway since the turn of the millennium.

Historically the most reliable barometer for this has been the bond market and most especially US Treasuries. Rising yields at the long end of the Treasury Yield curve suggest an inflationary era is dawning. Yet many respected analysts including Mike Green, Chief Market Strategist at Simplify Asset Management, suggest that the Treasury market yields are being distorted by mechanical momentum driven bond index funds, and that were it not for these interest rates at the long end would be much lower.

Most investors have been aware for many years of the influence index funds have on Wall Street stocks which has meant that (true) price discovery has become almost impossible in most listed stocks and most especially in the largest. This is because index funds do not study company accounts, analyse profits, or take notice of earnings announcements.

Since most of the investment that occurs on Wall Street is via regular monthly buy orders that come from 401K pension and other investment accounts, the momentum is usually upwards. Additionally, the rules that drive index fund investment results in most of the money invested into the market buys the shares of the largest companies in that index.

As an example, for every $100 invested by a 401K into a pension index fund replicating the S&P 500, just over $7 would be invested in Nvidia the largest stock, just over $6 in Apple and almost $4 in Microsoft, and so on. The smallest stocks in the S&P 500 will get pennies to the dollar by comparison with for example Factset Research Industries, Molson Coors Beverages Inc and Dominos Pizzas listed in the bottom ten by capitalisation getting just 1 cent each of the total $100 invested.

An investor utilising traditional fundamental analysis such as price to earnings ratios and balance sheet cash, etc. would likely conclude the latter three are massively undervalued and attractive long-term buys on a value basis. Conversely the analysis would likely conclude the big three are massively overvalued and, were you a hedge fund investor, a potential attractive shorting opportunity exists (i.e. borrowing shares you don’t own to sell in the market in the expectation of being able to buy them back cheaper at a later date to make a profit on the trade).

Historically, this is what investors would have expected, believing that the efficient market theory (EMT) would eventually mean your patience in value investing would be rewarded. However, if EMT ever existed, index funds have long since put paid to its continuing relevance as the mechanical momentum trades result in the largest stocks becoming increasingly overvalued, while unloved value stocks simply become more undervalued, but no less ignored.

As Mike Green explains, “roughly half of all the money in US stocks in now ‘passive’. It isn’t run by a person picking winners. It’s run by a rule, and the most common rule is ‘Own every company in the index, in proportion to how big it already is.’”

Mike uses a simple example to illustrate the power and distortion of passive investing in equities when he suggests, “Take the same group of giant companies and build two versions of a portfolio from them. In the first portfolio you put more money into the bigger ones – that’s the index rule. In the second you split your money evenly across all of them. The exact same companies with the only difference being how you weight them.”

Mike continues, “If these are simply wonderful businesses that earned their gains both portfolio versions should do equally well, because they hold identical stocks. However, that’s not what happens as the version that weights by size has steadily pulled away over the past 15 years and the gap means the very biggest are outrunning the “merely big”, not because they are better businesses but simply because of the act of weighting by size.”

Mike adds, “The size-weighting is itself producing the return with the effect strongest in the very largest stocks, weaker in the mid-sized stocks and basically absent in the smaller ones (excluding microcaps). For most of market history the cap-weighted concentration premium was virtually zero but has exploded in the past couple of decades with the advent of indexation.”

However, while the impact and influence of index funds on Wall Street stocks and to a lesser extent every other stock market in the world has been widely recognised by shrewd investors for a long time, what is less well known is the growing impact passive funds are having on the bond market, and particularly the Treasury market. This is now beginning to distort price discovery in Treasury interest rates and could result in many unintended consequences including making the once infallible bond market barometer of future economic growth unreliable, as well as discourage investment in the asset class if real time interest rates are no longer necessarily reflecting the underlying economy.

Mike Green in May highlighted this conundrum when he posted an open letter to the US Treasury Secretary highlighting how passive investment in bond markets was beginning to distort the yield curve. Mike has some radical proposals for trying to correct the distortion and potentially defuse the problem before it does further damage to the US banking sector which has been rendered largely impotent through holding excessive amounts of government debt from pre-Covid (2009 to 2021) when interest rates were at historic lows, but are now unable to offload these from their balance sheets because the price has dropped dramatically compared to the $1 par they were purchased at.

This distortion in the Bond market was further illustrated recently when the US Treasury 30-year bond was yielding more than 5% at one point last quarter, but few institutional investors were taking advantage of this opportunity to lock in a guaranteed 5% income for their retired or near retired investors, preferring instead to remain massively overweight an overvalued stock market yielding just 2%. This is the impact that passive investing is beginning to have on the bond market and only time will tell whether the authorities decide to adopt some of the suggestions from Mike Green and others on how to fix the broken price signals.

FORWARD OUTLOOK

The increasing influence of passive investing on bond markets is something we shall be watching closely but, in the meantime, we see no reason to change our current strategy. By adopting risk adjusted portfolios invested in global equities focused primarily on Wall Street stocks and in bond funds focused heavily on US Treasuries and other prime First world government bonds, investors can be sure their asset allocation combines optimal historic long-term returns, yield, volatility, and liquidity.

One of the unfortunate unintended consequences of the distortions we are beginning to see in the bond market is that artificially high interest rates at the long end of the yield curve suggest higher inflation is coming, whereas other fundamentals such as the collapsing oil price of oil, suggest a return to the deflationary trend that prevailed from the turn of the millennium until the post Covid reflationary spend. Barring any return to hostilities with Iran or, indeed, any new geopolitical flare ups elsewhere in the world (e.g. Taiwan), we expect US and global economic growth to return to normal.

While it remains to be seen whether there is any change of direction in Fed policy under the new Chair Kevin Warsh, it is encouraging to see the initial changes he is implementing in terms of data analysis. Anything that helps the world’s most influential central bank determine interest rate policy in real time can only be good news for investors.

We maintain our cautiously positive views on both the US dollar, which benefits from the enormous offshore eurodollar market, and the US equity market whilst continuing to diversify portfolio allocation into selective opportunities in the UK, Europe and Japan on a relative basis.

We would reiterate however, that caution remains the watchword considering increasing numbers of academic analysts echoing Mike Green’s long held view that the Efficient Market Theory no longer applies on Wall Street and increasingly globally, whilst new evidence suggests that  even the once incorruptible Treasury bond market is being distorted as market flows, not fundamental price discovery, drives valuation.

As always, investment risk is at the forefront of our advice. Whilst it is often necessary to undertake adjustments in portfolio allocation to meet individual needs and preferences, we are confident that our advised portfolios continue to remain well placed in meeting our clients’ overall planning objectives.

Copyright © Ash-Ridge Asset Management 1^st July 2026.

Data Sources: Bank Of England; Bloomberg; Brookings Institute; Columbia Threadneedle Investments; CNBC; Economic Cycle Research Institute; European Central Bank; Financial Times; Hoisington Investment Management; Macrotrends: Macro Voices; Office for National Statistics; S&P Indices; The Economist; The Federal Reserve; The National Bureau of Economic Research; Trading Economics; UK Debt Management Office; US Debt Clock.org; US Department of The Treasury; Wall Street Journal; Yahoo Finance: Yes I Give A Fig Thoughts On Markets – Mike Green Substack.