Barometer: Prospects for US, emerging market stocks remain strong

Asset allocation: calm after the storm

The storm in global financial markets appears to have subsided – at least for now. Much uncertainty remains, with no end in sight to the war in Iran, ships still stuck in the Strait of Hormuz and oil prices rising. But the worst‑case scenarios being debated a few weeks ago have fortunately failed to materialise, and the balance of risks today points to a more benign investment climate.

With the clouds having parted, investors can refocus on what are, on balance, positive fundamentals: ample global liquidity, strong corporate earnings momentum, steady if unspectacular economic growth, modest inflation (albeit with risks to the upside), and valuations which, for many asset classes, are more attractive than they were two months ago. All this makes us more comfortable adopting a modestly pro‑risk stance by adding exposure to emerging market assets, US equities and industrials.

However, our risk allocation remains selective: we would like to avoid reliance on a single macroeconomic or geopolitical development. We, therefore retain an aggregate neutral allocation across equities, bonds and cash.

Fig. 1 - Monthly asset allocation grid
May 2026

Our business cycle indicators support this view, suggesting a moderately positive macroeconomic backdrop for the world as a whole. The main message from the leading indicators we monitor is that economic activity remains broadly resilient across most developed economies and much of Asia, with only limited visible transmission from the energy shock so far outside surveys and price indicators. Our base‑case scenario remains that the global economy will grow by 2.8% this year, slightly above potential, while inflation averages around 3%.

But the risks are skewed towards weaker growth and higher price pressures. Indeed, if the closure of the Strait of Hormuz extends through the summer, it is likely to trigger a mild recession in Europe and some emerging economies, and potentially even in the US. While the waterway remains closed, oil prices are hovering at USD 110–120 per barrel, compared with pre‑war levels of around USD 70 and our model’s long‑term fair value of USD 80 (see Fig. 2).

The oil price surge is creating winners and losers. Emerging economies are holding up relatively well. Energy exporters are clear beneficiaries, but other countries are also in a stronger position than during previous shocks, reflecting better economic growth, lower external vulnerability and stronger rate buffers.

In the US, the situation is more balanced. The US consumer is arguably more fragile than headline growth implies: consumption data is already soft, disposable income growth has decelerated materially, consumer confidence is close to record lows, and higher oil prices are expected to squeeze real incomes further. However, the country’s oil producers are on track for a sizeable windfall, offsetting the overall impact on the economy.

By contrast, in Europe, the oil shock is clearly negative, with expectations of a recovery fading and the threat of stagflation looming. We have downgraded our euro zone growth forecast for the year to 0.9% (from 1.3% two months ago) and raised our inflation forecast to 2.7% (from 2.0%).

Fig. 2 - Oil uncertainty
Brent oil price scenarios by Strait of Hormuz closure length, USD/barrel 

Our liquidity indicators offer some comfort to riskier assets, supporting our decision to increase exposure to some equity markets. With little clarity over the duration of the inflation shock and whether governments might step in to mitigate the effects of higher energy costs, central banks have expressed an openness to tightening monetary policy, but are in no hurry to do so. Global liquidity, broadly defined as money supply, foreign exchange reserves excluding gold, and central bank assets excluding gold, is growing at around 7.4% – a full percentage point above the historical trend – underpinning valuations.

The US Federal Reserve has stopped cutting interest rates (and we do not expect any further moves this year), but private‑sector liquidity remains ample despite recent turbulence. We believe this is because key borrowers in the US economy – the government, AI‑related businesses and wealthier consumers – are not particularly sensitive to changes in interest rates. Furthermore, the latest corporate earnings reports confirm that bank balance sheets are in robust health and well insulated from disruptions in the weaker parts of the credit market.

Valuation indicators also justify taking on additional risk. Despite a strong rebound in equity markets, valuations do not appear excessively high. Global equities trade on a 12‑month price‑to‑earnings ratio around 10% below their October 2025 peak, while government bond yields have on average moved up some 40 basis points over the same period.

Corporate earnings dynamics remain supportive. The reporting season has been strong, particularly in the US, with technology, financials and materials delivering most of the pick up in earnings growth.

Technical indicators also point to a brighter mood than a month ago. Retail and institutional investor sentiment have rebounded firmly into bullish territory. However, there are no signs of over‑exuberance: net leverage is below average and investors remain braced for volatility, as evidenced by shifts in options markets.

Equities regions and sectors: liquidity and earnings fuel the rally

Despite fragile peace talks between the US and Iran, elevated oil prices and stagflation concerns, there are reasons to be a little more optimistic on the outlook for some of the world’s stock markets.

We draw encouragement from two factors in particular: abundant
private liquidity and strong earnings from major companies, particularly in economically-sensitive sectors like industrials and regions with a stronger growth outlook, such as the US and emerging markets.

What’s more, major equity indices are dominated by largely
service‑oriented companies, which means higher oil prices are unlikely to deliver an immediate hit to aggregate earnings.

US stocks look especially attractive, supported by strong corporate earnings, ample liquidity and the ongoing industrial and AI
investment boom. Companies in the S&P500 index are expected to post earnings growth of about 20% this year and next, the highest since 2021.¹

Particularly impressive has been the surge in corporate profit margins, a testament to strong cost control and high nominal economic growth. In all major markets, margins are expected to hit all-time high by the end of this year.

Just as importantly, the US has an ample liquidity buffer to shield it from external shocks. Our calculations show that liquidity created in the US, from money and credit, will rise to USD2.5 trillion, or 8% of GDP, from last year’s USD1.7 trillion or 6%, thanks to the Fed’s easier monetary policy stance, strong US bank lending and Treasury buybacks. For these reasons, we upgrade US equities to overweight.

Fig. 3 Value in core AI stocks*
US Core AI stocks trading well below post-ChatGPT average

We have chosen to do the same with emerging market equities. Companies in the emerging world are enjoying strong earnings momentum and appear relatively insulated from rising energy costs.

The macroeconomic picture is also positive. Growth remains robust, with the gap between emerging and developed market growth expected to widen to 2.6 percentage points this year from 2.4 in 2025. What’s more, the developing world is well positioned to benefit from the AI cycle, as it is home to some of the world’s largest chipmakers, such as Taiwan’s TSMC and Korea’s Samsung and SK Hynix — the trio that together make up nearly a quarter of the MSCI EM equity benchmark.

We maintain an overweight stance on Chinese stocks. Strong monetary and fiscal stimulus should underpin domestic demand, while rising industrial production and AI‑related exports should boost earnings in a market that has greater capacity than most to absorb external shocks.

We are neutral across non‑US developed markets, where equity valuations remain fair but significant uncertainty persists over the economic impact of the war.

At the sector level, we upgrade industrials to overweight. Industrial stocks are supported by global infrastructure spending and improving manufacturing trends. Capital expenditure in the US is booming, with core capital goods orders up 11% year on year in March.

We retain an overweight position in technology stocks, but prefer hardware and semiconductor companies to software firms. While the valuation discount from the recent sell‑off may prove temporary for a broad group of tech stocks, big tech companies’ investment plans for AI data centres and digital infrastructure this year — estimated at USD 700 billion — warrant a premium.

Healthcare is downgraded to neutral, reflecting weaker momentum across the industry and a less compelling earnings outlook relative to other parts of the market. We remain underweight consumer discretionary stocks, as rising inflation is expected to weigh on household incomes and discretionary spending.

Fixed income and currencies: increasing allocations to EM bonds

With no end in sight to the conflict in the Gulf, investors seeking protection from any renewed volatility in financial markets may be drawn towards developed world government bonds.

But the case for using them as a hedge is far from clear cut.

Bonds are being pulled in opposite directions. On the one hand, persistent inflationary pressures argue for higher yields.

The European Central Bank and the Bank of England have already signalled further monetary tightening, while the Fed—even under the ostensibly more dovish Kevin Warsh, who takes over as chair in May—is unlikely to cut rates this year, in our view. 

On the other, bonds could just as easily see their defensive qualities come to the fore once more.

Should higher energy prices begin to erode consumer and business confidence, recession risks would rise—and bonds would likely rally.
For now, these offsetting forces leave little room for conviction. We therefore remain neutral on developed market bonds.

Fig. 4 - Cheap currencies make EM assets especially attractive
Currency valuations by EM asset benchmark, indexed

That's not to say fixed income markets are lacking in attractive options for securing income. Emerging market local currency debt offers a very favourable risk-reward trade-off.

Fundamentals have improved meaningfully: debt levels average around 57% of GDP, far below the 128% seen in G7 economies, while fiscal positions are stronger.

Credit quality is consequently improving, with around 80 rating upgrades across the constituents of the JP Morgan EMBI emerging market bond index since early 2024.

Valuations remain appealing. Real yields—particularly in Latin America—are still well above those available in developed markets, providing a powerful income cushion. In addition, currency appreciation offers a further source of returns (Fig. 4).

The resilience of emerging market currencies during the latest energy shock is telling. The currencies of oil-importing economies, in particular, have fared better than in previous energy price shocks, suggesting structural improvements and sustained investor demand.
We therefore upgrade emerging market local currency debt to overweight.

We also maintain overweight positions in the Swiss franc and Japanese yen.

Both provide reliable protection in a stagflationary environment. The yen, in particular, stands out: the prospect of a widening of Japan-US interest rate differentials leave ample scope for a rebound.

Global markets overview: AI optimism fuels powerful rally

World stocks rallied nearly 10% in April in local currency terms, delivering one of their strongest monthly gains since late 2020.

Growing optimism about the end of hostilities in the Middle East and strong earnings from big tech companies in the US helped equities bounce back from their March sell-off. 

IT and communication services stocks led the advance with respective
gains of nearly 20% and 15% after their latest earnings reports indicated that robust spending on AI data centres and digital infrastructure was beginning to pay off.

Industrials rose nearly 9%, backed by improving manufacturing trends and moves by the US and other major economies to reshore their production base. More defensively oriented sectors such as energy and healthcare ended the month in red.

Fig. 5 - Looking past the oil crisis
World stock index hits all-time highs

Emerging market stocks were the best performers. Asian stocks rose 16% as the region, home to some of the world’s biggest chipmakers, benefited from a renewed AI trade.

Bonds ended the month broadly unchanged. Developed market sovereign bonds fell as rising inflation from the war in Iran raised concerns about hawkish responses from major central banks. Markets are now expecting all four of the world's major developed central banks to hike rates this year.

Japanese government bonds lost nearly 1% as surging oil prices heightened inflationary concerns, sending the benchmark JGB yield above 2.5% for the first time since 1997.

In contrast, emerging market bonds rose broadly, thanks to a weaker dollar, robust growth in developing economies and improved investor risk appetite.

In credit, both emerging market corporate bonds and high yield bonds generated positive returns, supported by improving risk sentiment and continued demand for higher-yielding assets.

In foreign exchange markets, commodity-linked currencies rallied across the board, with the Russian rouble, Brazilian real and Australian dollars among the biggest gainers. The dollar resumed its decline, falling nearly 2% and adding to its 2025 drop of nearly 10%.