Barometer: Stocks set for further gains as economic conditions remain benign

Asset allocation: stock rally to continue, bonds could suffer

Investors kick off 2026 with a global economy supported by broad-based monetary stimulus and robust growth in emerging markets. Pockets of stagflation and geopolitical concerns remain, yet overall the environment is conducive for pro-risk investment strategies. That continues to be the case even in the wake of the US's toppling of Venezuelan President Nicolas Maduro on January 3. Although the US's intervention is likely to have geopolitical implications over the medium term, it does not in our view move the needle for markets in the short-term – with the exception of providing a further boost to the gold price.

We therefore maintain an overweight stance in equities and an underweight positions in bonds.

Our business cycle analysis shows the global economy is experiencing steady if uneven growth, with emerging economies set to expand even faster than their developed counterparts in the coming year.

Our forecast shows the US economy will expand by 1.5% this year, below the consensus estimate for 2%. This more cautious outlook reflects our expectation for a slowdown in US household spending. At present, we observe an unusual gap in growth between consumption and disposable income. Over the past two years, US consumers have been increasing their spending at an annual rate of 2.9% at a time when their disposable incomes have risen by only 1.8%, indicating that households have been drawing down savings to sustain higher spending levels.

We expect this gap to narrow in the coming months. Consumers are likely to reduce their spending as the impact of tariffs and cuts to welfare programmes start to constrain budgets, especially among the bottom 40% earners. These pressures are likely to offset potential benefits from the Trump administration’s estimated USD200 billion in tax cuts.

What is more, we also expect more moderate capital spending, with artificial intelligence (AI) infrastructure investment slowing after growing by as much as 70% annualised in the first quarter of 2025.

The euro zone economy is likely to recover as households draw down excess savings while manufacturing rebounds with a lag in response to earlier rate cuts. However, the impact from fiscal easing, especially in Germany, will take time to materialise.

Japan’s economy is likely to grow moderately but at a slower pace this year. Consumer and business sentiment are improving while a fiscal package – the biggest since Covid and equivalent to 3% of GDP – should support households and strategic sectors such as semiconductors and AI.

China is also helping households with measures amounting to 0.5% of GDP after recent “anti-involution” policies have tempered manufacturing growth and domestic demand. We expect China’s growth to remain around potential this year at 4.6%.

Other emerging economies are showing broad-based growth as a combination of low inflation, monetary easing and rising global exports continue to provide support. They should also benefit from higher commodity prices in 2026.

Our liquidity analysis supports a pro-risk stance, with two-thirds of major central banks cutting interest rates. We believe the US Federal Reserve has largely completed its easing cycle following 175 basis points of cumulative interest rate cuts. While no further easing is necessary, the Fed may lower rates again if problems in the private credit market constrain bank lending; or if political pressure leads to further accommodation.

The euro zone has benefited from eight rate cuts since mid-2024 alongside fiscal easing, creating favourable conditions for equities. We expect the European Central Bank to cut rates once more and slow the pace of bond sales to prevent crowding out of private borrowers in the face of increased government borrowing.

China’s liquidity conditions are also positive as Beijing continues to counter weak domestic demand with moderately loose monetary and stimulative fiscal policies. The Bank of Japan is likely to hike twice in 2026 and extend its quantitative tightening, while fiscal spending supports growth.

Our valuation models remain positive for risky assets. We anticipate mid single-digit equity returns over the next 12 months, driven by robust earnings growth (see Fig. 2) but offset by a modest contraction in stocks' price-earnings multiples. US stocks appear stretched with the S&P 500 index trading at 22 times earnings, compared with a median of just over 18 times. Stocks in Switzerland and broader Europe are attractively valued, while those in Japan look fairly valued after a double-digit rally in Nikkei last year.

Technical and sentiment indicators point to strong investor appetite for emerging market assets, while US equity positioning appears elevated.

Equities regions and sectors: EM stocks to build on strong 2025

Equities look expensive but not extravagantly so and with abundant liquidity supportive of risk assets for at least the first quarter of 2026, we think stocks can rally further.  

That said, we are more positive about some markets than others. For instance, we maintain a neutral position on US stocks given broader concerns about the market’s valuation and our outlook for the US economy. The US equity multiple looks stretched at 22-times earnings against an historic average closer to 16-times, while price-to-sales ratios have surpassed dot.com peaks. Our proxy for the  US equity risk premium - the extra return investors should expect for holding riskier equities over bonds - remains in the high 2% range, which is historically low, though it would take a fall below 2% for us to consider going underweight the US market. 

Swiss stocks, by comparison, are very attractively valued – supported by their defensive characteristics, strong corporate fundamentals and improved prospects for its large pharmaceutical sector – and we remain overweight. We keep Europe more generally at benchmark- weight, with a preference for sectors that could benefit from both a continued cyclical recovery and from any traction on fiscal spending on defence and infrastructure such as industrials, financials and mid-caps, which have outperformed the US market over the past couple of years.

Our optimism about emerging market economies, which are benefitting from both a weaker dollar and further domestic monetary policy easing, means we continue to overweight both Chinese and emerging market stocks. 

It is impossible to discuss the outlook for equity markets without an assessment of AI-related stocks, which have powered markets higher across the globe. In our view, these stocks remain richly valued, even after having corrected somewhat over the past couple of months. Even so, a measure of rationality has crept back into this part of the market amid concerns about earnings quality and the growing reliance on debt to fund investments. Whereas investors were bidding up everything in this segment earlier this year, they are now being more discerning, resulting in considerable dispersion of valuations among these stocks as well as a decline in price-earnings multiples, as Fig. 3 shows. The upshot is that specialist knowledge has become increasingly important when  investing in AI. For now, however, we maintain our overweight in tech and communication services stocks given earnings strength across the sector.

We remain overweight the healthcare sector, which continues to look very cheap. Reduced policy uncertainty and a robust rebound in merger and acquisition activity open the door to unlocking considerable value in the healthcare sector – which also offers a hedge against a big correction in AI stocks.

We also remain overweight financials, which are likely to benefit from the Trump administration's push to deregulate the sector, and lingering inflation risks,  which should help keep the yield curve relatively steep and therefore boost bank lending margins. 

Fixed income and currencies: how low can Fed go?

In fixed income markets, all eyes are on the Fed: how will the central bank reconcile subpar economic growth with above target inflation, particularly in the face of mounting political pressure to cut interest rates? We expect inflation in the US to remain above target, averaging around 3% over the coming year. While economic growth will be far from spectacular – we forecast 1.5% GDP growth for 2026 –  there remains the possibility of a stronger expansion, particularly if AI-driven capital expenditure remains strong. We therefore believe that markets are overestimating the extent to which the Fed is likely to cut rates; we expect that future monetary easing will be limited to T-bill purchases, rather than the two to three further 25 basis point cuts implied by the market. Any upside surprises to growth or stalling disinflation could drive US yields higher, supporting our underweight stance on US Treasuries.

Although there is some risk of Fed independence eroding following upcoming changes to its governance make-up, we do not currently see a significant likelihood of this.

The inflation/growth mix looks more favourable on the other side of the Atlantic, which justifies our preference for European high yield bonds over their US equivalents. Volatility-adjusted yields look attractive in European high yield bond markets, while US high yield debt is approaching very expensive territory according to our valuation models.

Elsewhere, we remain overweight emerging market local currency bonds and emerging market corporate debt.  These assets benefit from benign domestic fundamentals, cheap exchange rates, relatively high real rates, continued investment flows and the prospect for higher commodity prices. Inflation is mostly contained, many emerging market central banks are easing, and global exports are exceeding pre-pandemic trends. We expect the GDP growth gap between developing and developed world to widen to 270 basis points in 2026 from 240 basis points last year; historically the widening of the growth differential gap has been followed by emerging market currency appreciation.

The Fed’s T-bill purchases are also likely to be positive for emerging market assets – and negative for the dollar. We expect the US currency to weaken versus the euro and the Swiss franc over the coming months.

We also retain an overweight on gold. Despite the metal trading at record highs, our models suggest that valuations are elevated rather than extreme. Macroeconomic trends are supportive with lower real yields, a weaker dollar, and elevated geopolitical risks underpinning demand for the metal. Emerging market central bank demand and inflows into gold ETFs remain strong, while incremental increases in gold allocations by US private portfolios could add to the upward momentum.

Global markets review: banner year for EM stocks and gold

From trade wars to actual wars, 2025 has been another tumultuous year. But that hasn’t stopped financial markets from setting fresh records. Global equities gained 23% in US dollar terms in 2025, notching up their third consecutive year of double-digit gains and paving the way for more peaks in 2026.

In contrast to 2024, European stocks outperformed their US
peers thanks to extensive fiscal spending plans (especially from Germany), prospects for more interest rate cuts and concerns about the increasingly tech-heavy nature of the US market. 

European stocks notched up fresh record highs in the final trading days of 2025, to finish the year 25% higher in local currency terms.  UK equities posted similar gains, delivering their best showing in 16 years as the FTSE 100 index closed in on the psychologically key 10,000 mark.

US equities had a flat December as markets fretted that inflation concerns could prevent the Fed from delivering further rate cuts, and as sentiment soured on the “Magnificent Seven” tech stocks. However, the world’s biggest equity market still posted gains of 18% in 2025 as a whole, following a 25% surge the previous year.

Emerging market stocks had a stellar year, with Latin America faring particularly well. Investors welcomed signs of improved economic stability in Brazil, with the resource-rich region also benefiting from a strong performance from metals and other commodities.

The strongest performance in 2025 came from Korean equities, which saw a near 100% gain – thanks to a mix of cheap valuations, the market's heavy tech weighting and improvements in corporate governance under a newly elected government.

Strong AI-related investment boosted industrial metals - copper among those setting a record high - while geopolitical and macroeconomic uncertainty fuelled demand for gold and silver. Gold rallied 65%, its biggest annual gain since 1979, on continued demand from both emerging market central banks and exchange-traded funds.  

Conversely, oil dropped 19% in its worst annual showing since a Covid-hit 2020. 

Within equity sectors, communication services and IT remained among the leaders for 2025 as a whole, despite some year-end wobbles.
There was also a strong showing from materials and industrials, while
consumer-related sectors lagged.

Global bonds marginally outperformed cash in local currency terms. The biggest gains came from emerging market debt, markets that were supported by lower inflation, higher economic growth and the prospect of further central bank rate cuts and currency appreciation.

European fixed income markets saw a sharp narrowing of the yield spread between peripheral countries’ sovereign bonds and Germany’s. US Treasuries, meanwhile,  held up well in the absence of a large credible alternative risk-free asset.

The dollar, however, decoupled from Treasuries to finish 2025 some 9% lower versus a basket of currencies. The greenback bore the brunt of worries about US trade policies and eroding institutional independence.