Monthly Digest: Still looking for what could 'go right'

Most investors have been pleasantly surprised: returns were higher than the long-term average last year (figure 1). Yet the general mood does not reflect that. Some are disappointed not to have made more, given another exceptional period for companies involved in the development of generative artificial intelligence (genAI); others remain fearful that some sort of market crisis is just around the corner.

It paid off to regularly ask the question “what could go right,” and more of that sort of attitude could be required in 2026 as all sorts of uncertainties continue to cloud the outlook.

Figure 1: UK vs World equity returns (2025)

Better than average

Amid the generally higher-than-average returns for equities, some markets did exceptionally well. There was a long overdue spurt of decent performance for the FTSE 100 (+22%) and a welcome return to form for European (+23%) and Emerging Market (+22%) equities. All of them outperformed the US (+8%) despite it being the home of the big technology leaders (performance data in sterling). Bond markets were relatively steady, with the odd wobble on concerns about government indebtedness (figure 2). This left balanced portfolios in decent shape. 

Figure 2: Two-year government bond yield

Even so, and as we anticipated a year ago, there were bouts of volatility. The main contributors to those were US President Donald Trump and the technology sector. The reaction to 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. But within days Trump had declared a ‘pause’ in their application. Markets rallied and have barely looked back since, as this pattern repeated itself several times, with diminishing effects, throughout the year.

Show me the money

There were three bouts of volatility related to genAI. The first was the January release by China’s DeepSeek of its large language model (LLM), reportedly developed on a shoestring budget. The reality was not quite as compelling, and confidence soon recovered. Still, if China does not possess the ‘brains’ of leading technologies, its access to plentiful cheap energy – a key input for datacentres – leaves it well placed to make progress through the employment of ‘brawn’.

The second moment of short-lived concern came with the summer release of an MIT study claiming that 95% of corporations employing some sort of genAI solution were seeing no benefit. We are very early in the adoption cycle and it seems that many of the users were trying to use generic LLMs where application-specific tools were needed. We remain confident that usage will evolve and deliver increases in productivity.

Still, with annual expenditure on data centres now running into the hundreds of billions of dollars, investors are keen to see a return on that investment, especially as more of it is being financed by debt.

We seem to have reached an inflection point where investors are demanding to see more revenue and profits before making further commitments. A big test could come this year if, as rumoured, both OpenAI and Anthropic (owner of the Claude LLM) attempt to list their shares on public markets.

Forward momentum

While trade and technology seem likely to continue dominating investment conversations, there ae plenty other things that merit our attention. Global economic conditions are generally favourable. Consumer and corporate finances are in decent shape, unlike those of many countries, and there has been a recent pick-up in surveys of business activity. With inflation lower, interest rates are falling in the majority of countries, and governments appear either unwilling or unable to cut their own spending. Even Germany has rediscovered the spending habit. A year of tariff-related uncertainty has left a potential backlog of (non-AI) capital investment that needs to be made. The probability of recession – one of the main threats to an equity bull market – is currently low.

Conversely, the risk might be that growth is too perky and inflation too sticky. That is certainly something we will continue to monitor, as will central banks. Core inflation in, for example, the US and UK, is proving slow to return to the 2% target. Our central view is that it is likely to remain generally higher and more volatile than in the pre-covid era, fuelled by political preferences (for more deficit spending and less ‘globalisation’) and issues such as climate change and demographics. It’s a key reason why we continue to prefer shorter-dated and less interest-rate-sensitive government bonds.

Although government bonds are unlikely to repeat the kind of losses they suffered as inflation spiked in 2022, longer dated bonds remain vulnerable to concerns about persistently high government debt. Precious metals have proved much better safe havens recently. We don’t expect last year’s strong gains to be repeated, but we continue to see a role for them in asset allocation, especially gold. We can also use actively managed funds, which are designed to provide steady but unspectacular nominal returns in different market environments. They will tend to lag strong bull markets but preserve capital when the going gets tough.

Political agendas

Politics will be on agendas again in 2026. Domestically, betting markets do not reflect much optimism about the Prime Minister or his Chancellor still being in office a year on from May’s local elections. A change of leadership could take Labour’s policies further to the left, a prospect that investors are unlikely to cheer. The pound is another barometer of political risk to keep an eye on. For now, it remains in the middle of the trade-weighted range held since the Brexit referendum.

On the other side of the Atlantic, the relentless political cycle moves towards November’s mid-term congressional elections. But there may be some upside here - with his favourability ratings at a low point for this presidency, Donald Trump may well be keen to whip up support and not create economic upsets.

Sailing into the wind

As we have for the last couple of years, we see balanced portfolios continuing to make gains into these headwinds. We, too, were pleasantly surprised by 2025’s returns, but in retrospect they were justified by strong corporate profit growth. Equity prices have risen further relative to earnings in anticipation of future growth, and it is harder to see valuations going up again this year. But we also continue to resist talk of a bubble in equity markets. Yes, the average price of shares in the US market looks elevated at around 22 times 2026 earnings forecasts.

But with projected earnings growth of around 13% and a core of very profitable companies, a specific catalyst such as an unexpected economic deceleration or sharply higher interest rates and bond yields (we’re not expecting either) would be needed to push valuations lower.

We also expect some broadening of returns this year. Other regional markets continue to offer more attractive valuations, and it wouldn’t take many things to ‘go right’ for them to attract further interest from investors. And a broader range of companies should experience productivity gains from the implementation of genAI in their processes. As ever, diversification is the key to sustainable returns.