In our final market update for 2025, our Investment Committee (IC) shared their perspectives on the year that was and what we might expect as we head into 2026. The IC also discussed elevated equity valuations including concerns over a potential AI bubble, the bond market and macro factors contributing to global markets.
What are your insights as we reflect on financial markets over the course of this last year?
Going into the end of the year, geopolitical events appear to be at a much lower temperature than they were during the first half, so a potential risk as we head into 2026 may be increased geopolitical risk. We are also heading into 2026 with very strong aggregate EPS growth outlook for issuers, having experienced the fourth year of double-digit EPS growth. We are likely to only get a slight cut in U.S. interest rates, so to have easing monetary policy in the U.S. with a strong aggregate earnings outlook, is quite unique and likely to have positive impact on financial markets. However, given the extraordinary returns over the last two years, skeptics will rightly question how long this can continue.
On the potential ‘tech bubble,’ is the EPS growth and market rally, particularly in the tech sector, sustainable?
At this point in the cycle, investors are rightly cautious. It is entirely possible that this earnings growth is self-sustaining and will continue to carry on for an extended period. Whether it’s driven by AI, quantum computing or a myriad of other factors, the reality of AI as we sit here today is that there is an awful lot of hope and very little delivery. If this is a bubble, what may cause the bubble to burst, is the fact that delivery will be slower than anticipated and expectations are not met. The equity market trades on an expectation mantra and is easily disappointed. As we see time and time again, valuations can become overvalued, people lose faith and then valuations are undervalued. We are at that stage in the cycle where people are being optimistic, even exuberant, however there’s always a chance that some of that confidence wanes and we see a shift downward. This is only of interest however, if you’re deploying capital into markets, less so if you’re already invested.
That said, the U.S. economy is resilient, and it’s got a tailwind in 2026 with respect to deregulation and tax cuts, which should limit the interest rate cut cycle. Aggregate earnings in the U.S. are extraordinarily strong; however the AI super-cycle is operating on forward guidance, and the rally is broadening out across sectors. Hence, the productivity gains out of the AI boom are legitimate, although, the key question is what one is prepared to pay for those earnings. ‘Bubble’ implies that investors are buying future earnings regardless of what is happening to the underlying share price, which is sort of happening but then isn’t. There is some exuberance, however, at 22 times forward earnings, the S&P 500, by way of example, is reasonably valued relative to other markets. In summary, there is a resilient U.S. economy, trailing earnings are holding up and are looking promising one-year forward and the AI ‘super-cycle’ is delivering productivity gains across multiple sectors.
What might we expect to see by the end of 2026?
The key consideration is trying to understand what we think will happen to corporate earnings over the year and what the outcome is of that versus investors’ expectations. Whether the same level of growth can continue over the coming year is important. Any slowdown in corporate earnings could cause investors to lose confidence in where equity prices are. Equity prices today reflect the investor buying earnings one-year forward and changes to expectations could result in volatility. We are heading into 2026 with healthy balance sheets and tight credit spreads, so whilst there is gearing in companies which comprise the small-cap index (Russell 2000), there is resilience in the U.S. economy with only pockets of resilience in other economies.
What can investors expect in the year ahead in fixed interest markets?
The main point to reinforce going into 2026 is the unevenness of monetary policy: the Bank of Japan is likely to raise rates—to the highest rate in 40 years—whereas the U.S. Federal Reserve is cutting with possibly one or two more rate cuts to come, whilst other major central banks aren’t cutting. In addition, remember that in the U.S., it is the 10-year and 30-year treasury bonds that fund mortgages and corporate America, so given the higher discount rate going into next year means higher borrowing costs so companies will have to be cash generative to cover their costs. However, from a fixed interest perspective, credit is tight, which means that the credit spread has converged to cycle lows, which is like saying the multiple on the S&P 500 is very high. This suggests that investors believe that corporate America is in reasonable shape to withstand shocks going forward. Hence, tight credit spreads are indicating the same thing as expensive equity markets. Even though fixed interest as an asset class is ‘defensive’ relative to equities because it has a low correlation to equities over the long-run and much lower volatility, going into year-end investment grade bonds are more expensive.
Interestingly, in the U.S., if you recall the impact of the Trump tariffs near the beginning of the year on consumption and particularly the pass-through to inflation, the effects have been negligible. Whether those changes impact the outlook for the U.S. 10-year government bonds for 2026 remains to be seen.
In Japan, rates on longer-dated paper are circa 2%, and even though there is little reason to believe that those rates should be significantly higher, at the same time the Yen has been consistently weak. That may start to change over the next 12 months.
What about currencies, commodities, and emerging markets?
The U.S. dollar weakness is no official policy in anyway, but the market is trying to gauge the value of the dollar. Whilst the U.S. would like a weaker currency in the short-term, in 2026, we will find out whether the structural weakness is real or whether the currency will come back. Because we don’t where this is exactly, emerging markets may stand to benefit, particularly from a weaker dollar.
If there are more interest rate cuts in the U.S. than expected, this will put the pressure of U.S. dollar weakness behind us. Europe has low cash rates, weak economic momentum and stubborn and sticky inflation, with a strong currency, so we know that the world is looking for alternatives. Don’t be surprised if mid-way or in the second half of next year the U.S. dollar begins to strengthen. Remember, currency markets are extremely sensitive and hence volatility is high, followed by interest rates and then equities.
We don’t believe that the U.S. economy is likely to tip into recession, however, at the same time a strengthening U.S. dollar is likely to cause other economies real problems. If we observe the U.S. dollar strengthening over 2026, economies such as emerging markets, may struggle despite being a beneficiary of a persistent weak dollar as of late.
Views on gold and its recent performance?
Ultimately, gold pays you nothing and you pay to store it. It’s a pure speculative investment and whilst silver has some industrial use, gold virtually has none. The reality is that gold has had a significant run up as investors believe it to be a safe haven investment. At this point in the cycle, we see no good reason to hold gold or silver. Furthermore, gold has been used as a volatility hedge, and in the case of Japan, an inflation hedge. We are heading into 2026, where commodities in general and energy are lower in price, however copper has had quite a rally and will likely be higher due to its widespread industrial use. That said, precious metals forecasts continue to march higher for 2026.
Given this backdrop, what should an investor sitting on excess cash do?
The OCR in New Zealand is now 2.25%, and inflation is circa 3%, so any surplus cash in the bank is going backwards on a real basis. Despite the current challenges around investing in fixed interest or equities for the above-mentioned reasons, our client strategies perform well due to the fact they are globally diversified, and we focus on your strategic asset allocation. One of the things we are mindful of in deploying capital in this environment is to stage investment into markets over a longer period of time to mitigate volatility. Our message is clear, with such low returns on cash, it’s worth considering investing into a diversified portfolio to achieve a higher rate of growth with the intention of keeping ahead of inflation.
Any final comments looking forward to 2026?
It is important to invest through the cycle, and if you’re investing from cash, deploy capital at a reasonable rate at this point of the cycle. In terms of priority, it may be more prudent to deploy capital into equities than any other asset class, largely because over the medium-to long-term, earnings growth will deliver capital growth.
The asset allocation framework is effectively giving the investor the highest possible return with the lowest level of volatility and this is ultimately your best protection. That said, looking at all the variables heading into 2026, geopolitics remains a risk, however the economic variables and forecasts are stacking up well given the resilience of the U.S. economy.