Global equity markets extended their winning streak and ended 2025 at fresh highs thanks to optimism over economic growth, corporate earnings, and a looser monetary policy stance from the Federal Reserve. Moreover, enthusiasm around Artificial Intelligence and easing trade tensions were met with an upbeat response from investors and added to the flight into risky assets towards year-end.
In local currency terms, the MSCI All Country World rose 3.3% in the fourth quarter. Regionally, the S&P 500 rose 2.9%. While indeed breaching new highs, concerns over lofty tech valuations limited gains versus its global peers. Meanwhile, the MSCI EAFE advanced 4.9% – while the MSCI gauge of emerging market stocks gained 4.7% amid mounting demand for shares tied to AI.
After an impressive year in 2025, we expect macroeconomic momentum to subside in 2026. Still, tariff-related inflation is likely to limit the ability of central banks to come to the rescue at a time when the economy is in need of support – putting downward pressure on both equity valuations (the “P” in P/E) and corporate earnings (the “E” in P/E). That translates into a double-whammy to stock markets in the coming 12-18 months.
Furthermore, after an unrelenting stock market rally, the starting point for both valuations and earnings forecasts are among the highest in four decades. That may prove to be an obstacle to further equity gains from here – and particularly in the context of looming macroeconomic headwinds at hand. Investors will need to navigate a plethora of headlines around trade, geopolitics, and the trajectory for monetary policy.
On the latter, markets are pricing in multiple Federal Reserve rate cuts over the next 12-18 months – which has been a significant driver of equity market strength over the last year. Should those expectations prove elusive, stock markets would undoubtedly re-price lower in response. Meanwhile, the AI frenzy and market exuberance over the prospects for future profits have sent valuations tied to AI and related technologies towards dot-com terrain. Any potential disappointment on the earnings and/or capital spending front could spark a sizeable correction in these high-flying stocks.
Investment Strategy
With a majority of our economic scenarios pointing towards a negative outcome for stock markets, we maintain an underweight stance on equities over our tactical 12-18 month horizon. Risks to the baseline are tilted to the downside, with the prospect of a revival in the trade war and/or a bust in the AI-trade raising the risk of recession. Barring a profound, investment-led productivity boom that extends the bull market in stocks (less likely in our view), we expect equities to remain on the defensive.