Looking back, it’s been another strong year for investors, part of a three‑year stretch that has been remarkably resilient. Generous fiscal policy, a turn in inflation, and the AI/data centre investment boom have kept growth and earnings resilient despite wars, tariffs and persistent cost‑of‑living stress.
Now, that tailwind is meeting a tougher reality. Valuations are generally high, and there’s a lot riding on another strong year of earnings.
So, what does that mean in practice? Markets still expect positive returns, but the margin for error is tighter than in prior years. The practical response is straightforward: keep total risk roughly neutral, tilt towards quality, diversify beyond listed markets, and have liquidity ready to take advantage of any dislocations.
2025 was another strong year. Global equities (hedged to AUD) returned close to 20%, while Australia lagged at around 11%. High yield credit delivered around 8%; core bonds were positive as inflation stabilised and policy rates started to ease. Gold surged (~60%) as investors paid up for insurance and the AUD strengthened against the USD. This capped a three‑year stretch of near 20% p.a. returns for global equities—an exceptional outcome given the shocks absorbed along the way.
Two forces did the heavy lifting. First, policy: for some time now, the world has been in a period of fiscal dominance. Across the developed world, budget deficits are material, with spending directed to infrastructure, energy, defence, and supply chains. Meanwhile, central banks have pivoted from fighting inflation to cautiously easing as price pressures retreated from their peaks. Second, earnings: US large‑cap tech continued to invest aggressively and deliver earnings growth. Markets have responded favourably, with the Nasdaq doubling since the launch of ChatGPT in 2022. The result has been a bifurcated market, clear ‘haves’ and ‘have‑nots’ with leadership concentrated in US large‑cap tech.
Something extraordinary is happening: demand for technology/AI and adjacent services seems to be occurring independently of broader conditions. Computer power and storage have become essential infrastructure, and everyone owns something that relies on it, regardless of demographic profile. Consumers might not be able to afford a home, but they can’t do without their smart devices, banking apps, streaming services and the other things that pervade our day‑to‑day, tech‑reliant existence.
As we look ahead, the macro picture is reasonable. Inflation is well off the 2022 highs, monetary policy is no longer as restrictive, defaults remain contained, and capex in AI and data centres is still running hot. On the surface, it’s a supportive environment for risk assets.
The challenge is that markets are priced accordingly and reflect a lot of this good news. Equity multiples sit well above long‑run averages in the US and Australia. Credit spreads are tight, edging toward levels last seen in 2007.
For these valuations to be justifiable, they require ongoing support from earnings. Analysts expect double‑digit growth, with implied 2026 S&P 500 EPS growth clustering around 13–15%, well above the long‑term trend of roughly ~8–9%. Earnings growth for the “Magnificent 7” is forecast at ~23% for CY2026 (slightly above the ~22% for CY2025). The big shift is expected from the other 493 companies, where earnings growth of ~12–13% is forecast for CY2026 (vs ~9–10% for CY2025).
For investors, this sets up a familiar but nuanced challenge: markets can still move higher, but there’s more room for mistakes, making portfolio balance, quality, and diversification more important than ever.
The question isn’t just what’s likely, but where expectations might be wrong − particularly in markets where valuations already assume a lot of good news.
First, while AI continues to advance, a small but growing number of commentators have noted that the advancement of large language models (LLMs) (e.g. ChatGPT) is continuing to improve, albeit at a diminishing rate. If this thesis is correct, the diminishing rate of improvement will potentially make a less compelling case for large scale capex programs.
Second, the commercial payoff for the high levels of capex is not yet proven. Broad‑based productivity gains and strong returns on capital need to be demonstrated. Over time, investors will increasingly demand evidence that AI investment is translating into sustainable returns, and sentiment could shift if that proof doesn’t materialise.
Third, energy remains a hard constraint. Data centres are extremely power‑hungry and grid upgrades/firming capacity takes time. Forecast energy demands from data centers are significant and there are two examples in the US where the data centers are operationally ready but unable to be electrified due to energy supply issues.
Any lingering friction to the otherwise bullish case for AI could dent the narrative. In a market priced for perfection, even small disruptions could trigger a sharp pullback.
Inflation remains a key wildcard. Two upside risks bear watching: delayed tariff pass‑through as pre‑tariff inventory rolls off and producers pass on more costs to protect margins, and continued fiscal spending combined with reduced monetary policy effectiveness as governments with large debts seek to ‘inflate away’ their burdens.
A less negative risk is the ‘melt‑up’: policy stays easy, AI capex and earnings surprise on the upside, and animal spirits push valuations higher. In a liquidity‑friendly world, it cannot be ruled out.
For investors, this creates a familiar tension: it’s hard to materially de-risk when liquidity is abundant and momentum remains strong. The challenge is staying invested enough to participate in upside, while keeping portfolios resilient if expectations unwind.
Access to private equity, private credit, real assets and infrastructure keeps expanding for wealth investors, particularly through evergreen structures. For these investors, this opens a bigger opportunity set – with the potential for better diversification, and if executed well, improved long-term risk-adjusted returns.
The investment case is reasonable, but the trade‑offs are meaningful. Higher fees, reduced liquidity, wide dispersion in manager quality, and valuation lags all need to be carefully managed. In this part of the market, selection and sizing matter far more than simply adding exposure.
Used well, private markets can become a powerful portfolio tool. Used poorly, they can introduce complexity and risk. The edge lies in disciplined manager selection, appropriate portfolio weighting, and clear client communication around time horizons and liquidity expectations.
Overall risk: For long‑term investors a broadly neutral risk stance still makes sense. If a client’s time horizon is shorter, or their risk appetite is stretched, it may be prudent to lean underweight and hold liquidity for more attractive entry points.
Quality bias: This is an environment that rewards quality and resilience. Tilting towards businesses with stable earnings, low leverage and strong balance sheets, help portfolios participate in upside while remaining better protected if market conditions deteriorate.
Diversification: Ensure portfolios are genuinely diversified across asset classes and risk drivers. Look to select private market investments and absolute return strategies that offer value relative to listed equivalents, subject to sizing and manager selection.
Liquidity: Maintain exposure to government bonds and cash. These are not idle allocations; they provide optionality to buy when others must sell. Liquidity is often most valuable when it feels least exciting.
Currency: Revisit currency hedging. If USD weakness persists (as many commentators are expecting), unhedged exposure is a potential headwind for AUD‑based investors. Thoughtful hedging decisions can meaningfully influence outcomes over time.
Looking ahead, there are a few debates we’re keeping an eye on.
Not by themselves, but they do put the spotlight on earnings. For new money, a disciplined approach, whether dollar‑cost averaging or opportunistic buying on market dips, makes sense. The same principle applies to liability management, by revisiting cash spending plans and trimming exposures at elevated valuations to provision for known outlays.
Then there’s AI. Parts of the market may be ahead of fundamentals. Capex is currently supported by cashflows, but markets will eventually demand proof that the spend translates into earnings. And of course, rates remain a key question. We may be in a ‘higher‑than‑normal but not excessive’ inflation world—somewhere between post‑GFC lows and 2022 highs. Without a shock, incremental rate adjustments and policy variability between countries are most likely, but the path will be bumpy as inflation in some parts of the world (e.g. Australia) remains sticky.
Taken together, these factors highlight the need for discipline, patience, diversification, and a clear plan for navigating both opportunities and risks.
When thinking about quality, it’s about positioning portfolios to participate in upside while staying resilient if markets wobble.
For Equities: Maintain core global exposures and lean into quality growth. If clients have ridden the US large‑cap tech trade, now might be the time to consider rotating some capital towards cash‑generative cyclicals and defensives that can benefit if breadth improves. Private Equity remains an important exposure for sophisticated investors.
In Credit: Favour higher‑quality carry over deep high yield given tight spreads. In private credit, prioritise structures with robust covenants and sponsors with proven workout capability. Quality here is as much about the manager as the underlying asset.
In Real Assets: Prioritise strategies providing access to high‑quality property and infrastructure (stable contracted cashflows, low leverage, some inflation protection) that have lagged listed equivalents. Focus on managers with a sourcing advantage and post‑investment value‑creation levers.
Within Alternatives: The goal is to back managers with a repeatable edge. With wide dispersion across countries, sectors and individual securities, there’s potential to uncover opportunities in long‑short strategies, but manager selection remains key.
For Rates: Bias to government securities for defensiveness and liquidity. Keeping some duration can act as a shock protection, while tactical additions on rate spikes can provide opportunities to enhance returns.
Across these asset classes, the principle is consistent, tilt towards quality, balance resilience with opportunity, and back managers or structures that can deliver it reliably.
The past year showed that markets can power ahead despite uncertainty. As we enter 2026, valuations are full. The easy gains are likely behind us. US large cap tech is priced for ongoing earnings growth, leaving little room for disappointment. But on the flipside, the economic outlook in the main appears reasonable.
One of the critical questions is whether the AI and the data‑infrastructure boom can deliver sustained productivity and returns, and whether energy systems can support it. If these challenges are met, the next decade could be transformative; if not, optimism may be tested. Another critical question is whether inflation becomes an issue.
For long‑term investors, a bit of everything is required, anchored around diversification, discipline and selectivity – all of which can help prepare for a bumpier path ahead. It’s not about chasing every hot trend, it’s about building portfolios that balance the need for resilience and being able to capture opportunities.
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