Reading between the lines in 2026

The outlook for the US economy remains caught between a soft labour market, resilient consumption and some signs of a broader re-acceleration in surveys. However, analysis of the world’s biggest economy has been somewhat hampered by the lack of official data due to the US government shutdown that occurred in late 2025. Labour market weakness has been in focus increasingly, with the recent uptick in US unemployment likely to influence the Federal Reserve’s thinking in the months ahead. November’s inflation reading was notably soft, though partly shaped by methodological factors, and may offer only limited support for additional easing. With uncertainty around the inflation outlook persisting, interest rate decisions in early 2026 are set to remain finely balanced as the Fed weighs conflicting signals.

Tax cuts as a result of the One Big Beautiful Bill Act are likely to encourage business investment and could support the US consumer. We see company earnings remaining solid and the potential for further merger and acquisition (M&A) activity. The big caveat to US equities is rich valuations, with many companies trading on relatively high price/earnings ratios. After a strong run, we may see more volatility going forward.

Elsewhere, there are signs of slowing growth in China as investment stalls, retail sales growth slows and house prices are falling faster again. The decline in fixed asset investment (a contraction of 2.6% over the January-November 2025 period) appears to have percolated through the economy, weighing on consumer confidence. While industrial output held up (up 4.8% year-over-year in November) despite the tariff shocks, domestic consumption in China remains moribund (see Figure 1).¹

In contrast, there are some signs of improvement in Europe. We believe that the German fiscal stimulus should begin to have an effect on the regional economy more broadly in 2026 and the European Central Bank (ECB) has already lowered interest rates meaningfully. To some extent, European equity prices already reflect this, with the STOXX 600 Index up 19.4% in euro terms (26.3% in sterling terms) year to date, and defence-related companies having performed particularly well.² However, European equities remain cheaper on a price/earnings ratio basis (16x forward earnings) than the US (22x forward earnings), with lower earnings expectations offering more potential for upside surprise.³ Geopolitically, a resolution of the Russia-Ukraine conflict would be welcome, although hopes have been dashed several times before and it is difficult to gauge what the impact might be on Europe’s economy and markets. There may be a relief rally which is tempered by the practicalities and costs of rebuilding Ukraine.

Market sensitivities around rates, geopolitics and AI

Markets remain highly sensitive to trade developments, signals on the interest rate outlook, and any indication of a slowdown in the artificial intelligence (AI)-driven investment boom. While reduced uncertainty around trade tariffs has supported risk assets, the recent rally in gold appears driven by expectations of lower interest rates alongside broader uncertainty — including geopolitical risks such as Venezuela, the potential expropriation of Russian assets in Europe, and continued central bank buying. Any perception that the Fed may ease policy more slowly than anticipated still tends to weigh on asset prices.

The AI theme could still have room to run in equity markets, but we should expect volatility along the way. Markets are likely to be more circumspect around whether AI adoption translates into meaningful productivity gains and can ultimately boost corporate profitability. A key question remains how countries manage structurally higher energy demand from data centres to support AI compute and increasing electrification. This, in itself, is creating new investment opportunities within infrastructure.

Fixed income markets likely to see more divergence

Within fixed income markets 2026 is likely to bring a more differentiated market. Most of the developed world has been in policy easing mode but 2026 looks to be a year of greater divergence. We can probably expect further interest rate cuts in the US and the UK, but it is looking increasingly likely that the next move in rates in Australia or Canada could well be a rise. Meanwhile Japan is expected to continue to normalise interest rates.

Government bonds remain caught between soft labour markets, concerns about government debt levels and worries among central banks about inflation reasserting itself. We await greater clarity on the US labour market as an indicator of global economic momentum that will likely dictate the medium-term trend in yields. Among corporate bonds, credit spreads (the difference in yield between a corporate bond and a government bond of similar maturity) remain low. This is a signal that markets are reasonably confident that companies can repay their debt. Nevertheless, this leaves little room for error and limited scope for spreads to decline further. While we think spreads could remain rangebound and yields remain attractive, we believe that investors need to be increasingly selective, particularly as we anticipate a rise in debt issuance in 2026.

All told, expectations are that corporate earnings will grow positively on average in most regions in 2026. This should support asset markets but we need to be mindful that markets have been on an extended rally since the lows of the Covid pandemic and valuations are not cheap. We believe it is too early to call the end of the current economic cycle but see advantages in having a diverse portfolio that can manoeuvre between different asset classes and potentially benefit from uncertainty.

¹Source: China National Bureau of Statistics, December 2025.
²Source: LSEG Datastream, EuroStoxx 600 Index, total return terms, 31 December 2024 to 22 December 2025. Past performance does not predict future returns.
³Source: LSEG Datastream, estimated forward price earnings ratios of MSCI USA and MSCI Europe ex UK Index at 22 December 2025. Forward price earnings reflect the share price divided by estimated earnings per share over the next 12 months. For an index this is done at an aggregate level. There is no guarantee that past trends will continue, or forecasts will be realised.