Allocation Views: Confidence, not complacency

Preview

Equity valuations are top of mind among investors as we move into February, amid stretched sentiment and positioning and challenging corporate earnings expectations. 

While we recognize these concerns as valid, we believe strong macro and corporate fundamentals should continue to support markets. Deeper analysis of growth, inflation and earnings gives us confidence that current optimism draws from solid foundations rather than irrational exuberance.

We believe rich valuations are justified by above-trend growth, which has combined with ongoing disinflation to create a “goldilocks” environment for equities. We also expect fiscal and monetary policy to be broadly supportive, dependent on the impact of political crosswinds. Beyond macro considerations, we view a healthy corporate earnings environment as bullish for risk assets.

Stretched sentiment and positioning is a contrarian indicator that supports a more bearish approach to risk, but in our view, strong fundamentals outweigh this.

Against this background, in this month’s Allocation Views, we remain modestly overweight equities within our policy portfolio, balanced by an underweight to fixed income. We also allocate to commodities and alternatives for diversification and hedging purposes.

Macro themes

A resilient growth story

• Leading economic indicators have strengthened, fueled by artificial intelligence (AI) capex (capital expenditure) and high-end consumers.
• Corporate sentiment appears strong, as evidenced by positive earnings revisions and guidance for calendar year 2026.
• The US economy has proven robust. Labor market data has softened from a strong position but is stabilizing and currently shows no signs of collapsing.

Moderating inflation trends

• Inflation remains above central-bank targets in most developed economies, although the trends are broadly disinflationary.
• Tariffs have been absorbed by both consumer prices and business margins. Core goods inflation could persist, but pressures have likely peaked.
• Services inflation has eased due to lower housing costs and wages, helping counteract higher goods inflation.

Policy leans supportive

• Economic crosswinds may prevent the Federal Reserve (Fed) from cutting rates again in the near term, but we expect moderate easing over the next year.
• Several major central banks remain in easing cycles, but the global policy environment has become more complex and is increasingly bifurcated.
• Fiscal policy in major economies is an increasingly influential driver of asset prices. We believe US tax refunds will likely offset tariff headwinds, while stimulus measures in Japan and Germany could also prove supportive.

Portfolio positioning themes

Responsibly bullish

• Positive earnings revisions and guidance support equity market momentum, outweighing valuation concerns, in our view.
• Leading and current indicators of economic strength remain broadly positive and support risk assets.
• Sentiment and positioning have become more stretched. We believe this is a slight headwind for risk assets and feeds into the ongoing valuations debate.

Opportunity in emerging markets (EMs)

• Earnings expectations are rising rapidly across EM ex China, influencing our more constructive view on the region. Macro conditions are also supportive.
• We retain our optimistic view of US large-capitalization stocks, relative to small caps and regional equities. Robust earnings and a supportive macro backdrop guide our thinking.
• We remain broadly pessimistic toward international-developed market equities.

Underweight government bonds

• Strong growth is challenging longer-term market expectations for Fed easing, in our view. Elsewhere, central bank rhetoric has become more hawkish recently.
• Fiscal deficits are widening in major economies, as governments increase spending or cut taxes to stimulate growth. Consequent yield effects make us selective on duration.
• Tight spreads diminish the risk-adjusted returns available from credit. Earnings growth leads us to favor equities.