An Impossible Trinity

Expected volatility from central bank policy divergence, earnings uncertainty, and geopolitical risks – all suggest quarterly tactical adjustments over static full-year allocations. Key inflection points to monitor (a) Earnings – will live up to the hype, especially for big-tech (2) Inflation trajectory & Jobs market – critical for FED path (3) AI ROI clarity (tangible productivity gains?).

Primary downside risk to consensus is inflation revival. Multiple triggers could push inflation back up (1) Deglobalization increasing production costs (US tariffs at 1930s levels), (2) Commodity price spikes from AI energy demand and underinvestment, (3) Wage-price spirals in tight labor markets (4) Fed policy contradiction—why ease if economy strong? If inflation reaccelerates, Fed forced to pause/reverse cuts, undermining entire bull thesis for equities and credit.

At 22.5x forward P/E (vs 18.7x 10-year average and 21.75x 5-year average), S&P 500 has zero room for multiple expansion. All gains must come from earnings—no valuation cushion exists. Consensus projects aggressive c15% EPS growth, with Mag 7 needing to deliver 22% growth while S&P 493 contributes 9%. This is achievable but requires flawless execution. Any earnings disappointment triggers multiple compression. We advocate focusing on companies with visible earnings trajectories, defensible competitive moats, pricing power, strong balance sheets. Quality matters more than momentum.

We remain cautious on Europe’s aggregate performance potential in 2026 – it’s hard to envision the Euro Stoxx or FTSE indices outperforming unless there’s a significant global upturn or a policy-driven economic surprise in Europe. Pockets of opportunity exist in Luxury (reasonable valuations in strong businesses) , Industrials & AI Beneficiaries  (semi equipment, power management, automation, cooling systems) and the Defense Sector (upward trajectory on budgets driving multi-year order books).

While US tech dominates headlines, genuine opportunities lie in selective international exposure. Specific opportunities: (1) India 6.3-6.4% GDP growth with earnings momentum returning post-2025 reset, (2) North Asia tech supply chain (Taiwan/Korea semiconductors) capturing AI infrastructure demand.

Just as the economy is operating on a two-speed trajectory, so is the equity story – the tech “haves” and the “have-nots”, with the former immune to the macro narrative. Rising capex, circular deals and the hype have all the makings of a “bubble”, but one that has more to go, for now, and for some. Markets overestimate the impact of technology in the short-term and under-estimate it in the long-term. One of our key themes for 2026 is a potential rotation into undervalued defensive sectors that have lagged during the tech-dominated rally. Notably, healthcare and consumer staples.

Investment grade credit spreads at 70-80bp and high yield at ~300bp represent decade tights - spread compression has run its course. Risk-reward is asymmetric - if spreads widen 50bp (entirely plausible if economy slows or corporate defaults increase), you lose 5-6 months of carry. We prefer US Treasuries for: (1) Inflation protection—if our concerns materialize, Treasuries preserve purchasing power better than credit, (2) Duration optionality—if labor market cracks, Fed cuts aggressively and long-end rallies, (3) Liquidity—Treasuries most liquid during stress, (4) No spread risk. Favor intermediate duration (5-10 years) balancing carry and convexity.

Precious metals have had an exceptional run – gold for three years and for silver, a sterling 2025. Marked by investment flows, Gold has outperformed equities but underperformed silver with the latter witnessing an unprecedented supply squeeze. Silver appears more speculative and susceptible to unwinds. The long-term view on gold remains positive, but unlikely to be a straight, secular uptrend.

Commodity markets - Demand linked to the AI growth story, notably copper and uranium creates optimism, BUT weak demand from China, and a focus on alternate energy, continues to weigh on energy prices, especially oil. Marked by a severe under-investment in capacity, the case for a secular bull market in commodities remains an opportunity, but will also be a hostage to cyclical trends.

While it’s easy to be bearish the US Dollar, and we are longer-term, the bigger question is “what’s the alternative”? Any challenge to the Dollar’s dominance is restricted by challenges faced by the major fiat rivals. Besides, can an export driven Europe, UK, afford significant currency strength? While reserve diversification will continue and particularly into alternate currencies such as gold, this is a long-term story. A lack of deep treasury market also limits diversification into EM currencies.