Key highlights:
- Global growth looks solid and should accelerate in 2026.
- Inflation is a mixed picture but should not be a major issue for markets next year and could surprise on the downside in the US.
- The Fed will continue to cut rates during 2026, but perhaps by less than expected.
- The outlook for bonds is mixed and a focus on credit quality, shorter maturity issues and attractive yields remains sensible.
- The equity bull market is intact, but volatility will pick up and leadership is changing.
- We may well be in an “AI” bubble but if so, there is likely further to go and there is the possibility that the global economy will be a huge beneficiary of a disinflationary rise in related productivity growth.
- The Dollar is likely to continue to depreciate long-term. Sterling is also at risk.
- Gold remains in a bull market as are industrial commodities.
- Geopolitics, the “changing world” and “fracturing world economy” will be powerful influences on the global economy, financial markets, capital flows and policy makers for years to come.
- Key risks – US slowdown, AI disappointment, a new geopolitical shock, Fed disappointment.
- The macro background is changeable and uncertain and provides both risks and opportunities – we have adapted our investment strategy appropriately and will continue to do so.
The investment backdrop
Looking back at 2025, it’s fair to say that investors have enjoyed a much better year than expected given the challenging economic and political backdrop and the largely negative media headlines. Last year can really be characterised by rising protectionist and geopolitical shocks and surprising economic and market resilience. Moving forward, we remain in a period of significant change and policy uncertainty, so the future direction is still unclear, but at this juncture the investment outlook remains positive.
Global growth and regional policy shifts
Global growth looks solid and is set to accelerate next year. Although there are some signs that the US economy, and the labour market specifically, may be softening, and we are still waiting to see the full impact from tariffs, the risk of a serious slowdown or recession seems low at this point. Indeed, the US economy could surprise with faster growth than anticipated next year for a number of reasons; the consumer remains strong, businesses are investing heavily in AI and new technologies, productivity is rising, the Fed is cutting rates and fiscal policy remains supportive. Importantly China, as the world’s second biggest economy is embarking on targeted monetary and fiscal easing to improve its growth prospects. At the same time, the economy is also experiencing an AI boom, though the pattern differs from the US model.
It is also encouraging to see Germany abandon its fiscal restraint and target “higher growth”, through a €500 billion infrastructure and defence spending plan. This is long overdue given the structural problems which plague the economy and Europe generally, namely deteriorating competitiveness, overregulation, supply-side deficiencies and a brewing fiscal crisis in France. A stronger and more expansionary Germany will benefit the rest of Europe as well.
Japan is adding to the reflationary impulse with the new Prime Minister Takaichi announcing a $135bn stimulus package. Whilst the UK is also struggling with a stagflationary growth and high inflation environment, along with many of the same long-term challenges as Europe, the economy could pick up modestly in 2026 as interest rates fall further and as business and consumer confidence improves.
Markets, inflation and monetary policy
Equity markets have benefitted from a strong recovery in corporate earnings thanks to resilient growth. In addition, lower interest rates, continued excitement around the AI story, lower energy prices and an easing of tariff concerns over recent months have added to the positive story. Looking forward to next year, the combination of expansionary fiscal policies in many G7 economies, lower interest rates, cheaper energy prices and a further easing of the uncertainty around tariffs should see a modest acceleration in global economic activity. This will continue to support corporate earnings. In addition, inflation should not be a major issue for markets, at least for the next few months. Inflation remains uncomfortably above target in the US and UK, but it has stabilised. Meanwhile, China continues to struggle with deflation, while in Europe and many emerging economies, inflation is less of an issue. Another supportive factor for equities is that there appears to be plenty of liquidity available in money market instruments and global reserves to support both economic growth and markets.
Going into 2026, there are plenty of reasons for caution, as there always are, but I remain bullish on the outlook for markets, and equities, in particular. This is largely because I expect the positives that I have already outlined to continue to drive markets higher over the next year or so. For example, provided inflation remains stable, the Fed should deliver additional interest rate cuts, despite a relatively strong economy. With clear signs that rising productivity from AI is starting to displace workers in some sectors, and with Trump determined to tighten up on immigration, the Fed will be focused on the “full employment” part of its mandate. In addition, inflation could surprise on the downside as the year progresses thanks to rising productivity from AI, fading tariff effects, falling rental costs and the delayed impact of weakening wage growth. The Fed has also announced the end of Quantitative Tightening (QT), which will help alleviate any liquidity concerns within the US economy or banking sector, whilst helping to keep a lid on US Treasury bond yields. On a more cautionary note, whilst I remain optimistic on the market outlook, equities have had a good run and I expect volatility to increase over the next year or so given the multiple threats to the rosy scenario that I have described and also the fact that we are moving into the late economic cycle period. However, unless there is a material change to the outlook, we would view any short-term weakness in equities as a buying opportunity.
AI momentum continues (for now)
Also positive for equities is that the AI story remains strong. Whilst there are legitimate concerns that the potential returns on the huge sums being invested in the sector, particularly by the hyperscalers, may disappoint, I think this story has some way to go. AI and other tech innovations are having a profound and largely positive impact on productivity and therefore growth. This is certainly true in the US but also in many other economies as well, including China and Europe. Rising productivity would be bullish for global growth and corporate profits. while helping to keep inflation under control.
Many commentators and investors are comparing the unfolding AI story to the Dot.com bubble in the late 1990s, which I remember well. There are some similarities but there are some important differences too: the companies spending heavily on data centres and AI are very profitable with strong balance sheets and healthy cash flow. Unlike the late 1990s, corporate earnings are currently robust rather than contracting and most hyperscalers are financing their investments out of cash flow rather than debt. We are also not seeing a big increase in new companies listing on the market, nor the euphoria and overly optimistic sentiment that prevailed at the top of the market in early 2000. In fact, the prevailing view seems to be that equities are vulnerable after rapid gains since 2023 and that the US market is already in “bubble” territory. Bull markets rarely end when there is so much negativity and scepticism around.
From a valuation perspective, whilst some areas of the market look overvalued and expensive (mainly non-profit technology companies, cryptos etc), valuations look reasonable in many sectors and stocks, including most US companies. Even the high valuations of the mega-cap tech stocks are largely justified by the strong financial fundamentals, such as profit growth, margins, return on capital and cash flow. In the meantime, there are lots of attractive investment opportunities outside of the US in Europe, emerging markets, China and Japan. This is especially true as these countries look to strengthen their growth prospects through easier monetary and fiscal policies and other means.
Asset positioning
One of the features of 2025 is that US equities underperformed global markets in currency-adjusted terms. Given the global macro background, this is likely to continue as a trend over the next year or so. Mega Tech (both US and China) should remain a core holding given the strong fundamentals and powerful momentum. However, this should be complemented with other attractive global stocks that will benefit from accelerating global activity, expansionary monetary and fiscal policies, strong earnings growth and a strategic pivot from investors which is primarily being driven by the rapidly changing geopolitical and economic environment. Currency is also a consideration, given the long-term prospects of further Dollar weakness as the government takes on more debt and continues to run large budget and trade deficits. Many of the outperformers during the past year look set to have another good year, such as financials, energy, mining, defence and health care. Smaller and mid-cap companies should also do well if growth accelerates as expected. Finally, emerging markets and Asia especially have enjoyed a stellar year and are likely in the early stages of a bull market given the many supportive factors as previously outlined.
This macro environment is also supportive for bonds, although caution is required in relation to sovereign bonds, and especially longer dated maturities given rising fiscal deficits, the risk of higher inflation, concerns over the structural decline of the Dollar and an ageing demographic. Having said that, if US inflation falls more than expected later this year thanks to accelerating productivity, softer wage growth, cheaper energy, higher unemployment and a more dovish Fed, Treasury and other sovereign bonds could do better than expected, which would further support equities. The outlook for credit markets remains positive given the strong corporate fundamentals, prospect of additional rate cuts and attractive yields available. However, from a risk perspective, it makes sense to continue to avoid taking unnecessary duration or credit risk. Finally, Chinese sovereign bonds should continue to perform strongly given that deflation is persisting whilst emerging market debt is also attractive on a selective basis and in view of the potential for further Dollar weakness.
The Dollar stabilised in the second half of 2025 after a significant decline. Consensus is again bearish on the Dollar looking forward and I broadly agree with this for reasons previously mentioned, although the currency is likely to stay supported over the next few months. The Yen remains extremely undervalued and will eventually change trend once the Bank of Japan turns more hawkish, whilst the Chinese Yuan and many other Asian currencies should gradually appreciate over the next few years thanks to superior economic fundamentals and shifting capital flows.
Gold, which has been one of the strongest performers in the last year, continues to be in a long-term bull market. Central banks are big buyers of gold as they diversify their reserves away from US Treasuries. Retail investors are attracted to gold due to rising deficits and debts, the devaluation of fiat currencies, and an increasingly uncertain geopolitical world. Other commodities could also be in the early stages of a bull market if global growth accelerates as expected and given the impact of the changing world order and fracturing global economy.
Geopolitics and a changing world order
The key risks for markets include a worse-than-expected US growth slowdown, a major deterioration in US/China relations, a UK economic or financial crisis, a spike in energy prices on an escalation of the Russia/Ukraine crisis, a messy handover of the Fed Chair from Powell or a major disappointment around AI. Markets may also react negatively initially should the US Supreme Court rule against some of the Trump tariffs, although this would likely be relatively short-lived as the administration would seek alternative measures. We must also remember that the geopolitical landscape will continue to become more complex and difficult to predict, not just over the next year but longer-term as well. There is plenty of scope for both negative and positive surprises here, although I expect tensions to ease modestly in 2026 as Trump shifts his focus towards the midterm elections and a stronger economy. Potential positive surprises include an end to the Russia/Ukraine war, an improvement in US/China relations, stronger global growth than expected and another very positive year for equities.
The past year has underlined just how important and influential macro and geopolitical forces have become for both the global economy and markets. The AI investment boom, US-China tensions, the changing world order, shifting capital flows, Germany’s decisive fiscal U-turn, building fiscal risks and a weaker Dollar are all good examples of this. These themes, as well as long-term trends such as an ageing demographic and the rise of the emerging market consumer, together with some new and emerging trends, will continue to have a powerful impact on markets for the next year and beyond.
The good news, as has been amply demonstrated last year, is that this is not necessary negative for either economic growth or market performance and change can be good. However, as I have previously explained, we are in a very different world to that which prevailed for the period from 2008 until Covid struck in 2020, and a different investment approach is required. Consequently, we will continue to adapt our strategy as we believe to be appropriate, looking to take advantage of the many attractive opportunities that we see whilst ensuring that we remain firmly focused on managing the risks as well.
