Investment Update Q1 2026: Alarms and (pleasant) surprises

5 January 2026

We review the financial markets over the past year – including bouts of volatility right up till the final few weeks of 2025.

John Wyn-Evans, Head of Market Analysis

Article last updated 5 January 2026.

Quick take:

2025 returns for equity markets were higher than average, with some markets doing exceptionally well.
The tech sector suffered three bouts of volatility, including profit-taking at the year’s end.
As 2026 begins, economic conditions are generally favourable..

The year’s end provides, along with the Christmas pudding, Brussels sprouts and ephemeral resolutions, the usual seasonal opportunity to look back on the past 12 months, take stock of the current situation, and share some thoughts about what might happen in the new year and how we should position portfolios.

Most investors have been pleasantly surprised by higher returns than the long-term average this year. Yet some are disappointed not to have made even higher returns, given further exceptional outperformance from companies developing generative artificial intelligence (genAI).

Others remain fearful that a market crisis is just around the corner.

One question we regularly asked ourselves during 2025 was “what could go right?”

Looking back on the year, a more positive mindset paid off. A similar attitude could be required in 2026 as all sorts of uncertainties continue to cloud the outlook.

Welcome bouncebacks

In 2025 UK, European and emerging stocks enjoyed long-overdue spurts

Better than average

Annual returns for equity markets generally were higher than average, with some doing exceptionally well. There was a long-overdue spurt of decent performance from the FTSE 100 (up 25.8 %) and a welcome bounceback for European (up 26.8%) and Emerging Market (up 25.1%) equities. They all outperformed the US (up 9.8% for sterling investors) despite it being the home of the big technology leaders.

Notwithstanding wobbles over fiscal concerns, bond markets held relatively steady, with returns roughly in line with the yields offered at the beginning of the year. This left balanced portfolios in decent shape.

Even so, and as we anticipated a year ago, there were bouts of volatility. In the main, these were driven by President Donald Trump’s policy salvos and the technology sector.

Trump’s ‘liberation day’ tariffs announcement triggered a near-20% fall in US equities and accompanying weakness in bond markets and the dollar – a rare and destructive combination of market moves. But within days he’d put the tariffs on ‘pause’. Markets rallied and have rarely looked back since.

However, there was another wobble in October, when Trump threatened punishing restrictions and tariffs on China again. That bomb was quickly defused when Chinese President Xi Jinping warned of retaliatory tightening in export controls on the rare earth minerals crucial to manufacturing supply chains.

Given President Trump’s fondness for using trade threats as a policy weapon, we can only expect to see more of the same in 2026, perhaps triggering further market volatility.

Show me the money

The volatility around the technology sector, and around genAI specifically, came in three separate episodes.

In January, Chinese company DeepSeek released its large language model (LLM), which it claimed had been developed on a shoestring budget. That sent the share prices of the big US tech players into a tailspin. But the DeepSeek model proved less compelling than it first appeared, and confidence soon recovered. Even so, a warning shot has been fired, and investors will continue to monitor China’s AI/LLM progress. It may lack leading technologies, but its access to plentiful cheap energy – a key input for AI data centres – leaves it well-placed to make progress through the employment of ‘brawn’ rather than ‘brain’.

Forward momentum

Economic conditions globally are generally favourable. Consumer and corporate finances are in decent shape, unlike those of many governments, and purchasing manager surveys have picked up recently. Interest rates are falling in most countries against a background of lower inflation, while governments remain reluctant to consider cutting expenditure. One of the main threats to an equity bull market is a recession, but this is currently a low-probability outcome.

Conversely, there’s a risk that growth is too perky and inflation too sticky. Our central view is that inflation is likely to remain generally higher and more volatile than in the pre-Covid era given political preferences (more deficit spending and less globalisation) and issues such as climate change and demographics. That’s a key reason why we continue to maintain a relatively short maturity profile in our government bond investments.

Government bonds proved a very poor diversifying asset in balanced portfolios in 2022. While the sizeable repricing that occurred then is highly unlikely to be repeated, longer-dated bonds remain vulnerable to concerns about persistently high levels of government debt.

Precious metals have proved much better safe havens recently. We’re not expecting them to make further similar gains, but we believe they have a role to play in asset allocation, with gold still preferred.

Political agendas

In the UK, betting markets don’t reflect much optimism about his chances of Keir Starmer being in office a year hence (the same goes for Chancellor Rachel Reeves). A change of leadership is widely expected to take Labour’s policies further to the left, something investors are unlikely to cheer. Political risk is often expressed through the level of the pound, which may prove a helpful barometer in 2026. For now, it remains in the middle of the trade-weighted range it’s held since the Brexit referendum.

On the other side of the Atlantic, the relentless political cycle moves towards November’s mid-term Congressional elections. Given his low favourability ratings, Trump will be keen to whip up support and avoid economic upsets.

Remaining constructive

We remain constructive about the outlook for balanced portfolios, while not getting carried away.

We too have been pleasantly surprised by this year’s returns, but, in retrospect, they are not unjustified given strong corporate profit growth. Equity market valuations have risen in anticipation of future growth, and it’s hard to see that card being available to play to the same extent in 2026. But we continue to resist talk of a bubble in equity markets. Yes, the US market’s price/earnings ratio of around 22x, based on forecast 2026 earnings, looks elevated. But with projected earnings growth of around 13% and a core of very profitable companies, a derating would need a specific catalyst, such as an unexpected economic deceleration or sharply higher interest rates and bond yields. We currently expect neither.

Other regional equity markets offer more attractive valuations, though admittedly they lack the same weight and calibre as world-leading index constituents.

We also anticipate some broadening of returns in 2026, as companies reap productivity gains from genAI implementation. A recent upturn in the fortunes of the healthcare sector, for example, provides clues as to where investors might look next. As ever, we see diversification as the key to sustainable returns.

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