One of the most challenging parts of investing is resisting the temptation to react to short-term news. The scale and efficiency of global investment markets mean that information is quickly reflected in asset prices, often regardless of how relevant that news may be to long-term fundamentals. Investors also tend to get ahead of potentially positive developments and extrapolate negative ones, which can lead to exaggerated market moves and, ultimately, corrections. These reactions are what we experience as portfolio volatility. While uncomfortable over short periods, volatility is an unavoidable feature of investing unless one exits markets altogether.
With Donald Trump continuing to generate headlines and geopolitical conflicts persisting globally, 2025 experienced its fair share of volatility, and we expect 2026 to be similar. The instinctive response in such environments can be to step out of markets and wait for a return to ‘normality’. However, the long-term cost of doing so can be far greater than the short-term discomfort of remaining invested. A useful and recent example is Trump’s so-called ‘Liberation Day’, when sweeping tariffs were announced, notably including those affecting the penguin inhabited Heard and McDonald Islands.
In the aftermath of the tariff announcement, markets fell sharply amid fears of retaliation, prolonged trade wars and stagflation. The global stock market (represented in this example by the MSCI World Index) fell by approximately 13.5%*, with much of the decline occurring in a single day. Investors who sold during this volatility accepted a potentially smaller immediate loss and avoided further volatility but also removed themselves from the opportunity to benefit from any recovery. Rather than escalating, US policy subsequently pivoted, markets stabilised, and the MSCI World Index ended 2025 with a respectable gain of around 12.7%*.
Setting political rhetoric aside, 2025 was characterised from a macroeconomic perspective by the gradual normalisation of inflation and interest rates, albeit with both remaining above target in the UK and US, alongside subdued economic growth. This more benign backdrop supported relatively strong returns across most asset classes. With the usual caveats about the clarity of our crystal ball, there are several reasons to be cautiously optimistic about the outlook for 2026.
Assuming no significant deterioration in growth, further gradual easing of monetary policy during 2026 would, again, be broadly supportive for most asset classes, though less so for cash. The UK economy continues to walk a narrow path. Growth slowed during the second half of 2025 and business confidence remains fragile amid elevated costs and ongoing fiscal uncertainty. Despite this, the FTSE 100 delivered strong gains over the year and UK equity valuations, particularly for small and mid-sized companies, remain attractive. For UK larger companies, a natural concentration in reliable dividend payers becomes increasingly appealing as interest rates fall, while a bias towards sectors such as defence, mining and consumer staples may provide useful diversification from markets with more tech and growth exposure.
In Europe, political risk remains the norm rather than the exception. Instability in France and the continued rise of populist parties in Germany pose challenges for the region’s two largest economies. That said, Eurozone inflation has largely returned to target and interest rates are now meaningfully less restrictive than in the UK or US. European equities share many of the attractions of UK equities, including more reasonable valuations than their US counterparts, alongside exposure to high-quality luxury brands. These companies underperformed as Chinese growth slowed but may benefit should demand continue to recover.
US large-cap equities, and the ‘Magnificent Seven’ in particular, dominated markets in 2024 and much of 2025, though momentum faded towards the end of the year. Enthusiasm around artificial intelligence drove substantial inflows, pushing valuations of some companies yet to generate profits to elevated levels and prompting comparisons with the dot-com bubble. The key distinction to the early 2000s is that many of the companies central to the AI theme, such as Microsoft and Alphabet, are highly profitable and delivering genuine innovation, which may justify higher valuations and continued inclusion within portfolios.
Elsewhere in the US market, valuations appear more reasonable. Companies are adjusting to higher costs arising from tariffs and, with mid-term elections approaching and signs of strain among the US consumer, there is a meaningful chance of politically motivated fiscal measures, such as tax cuts, which could provide support. Our positioning in the US therefore remains broadly unchanged: caution towards the most speculative areas of the AI theme, selective exposure to companies demonstrating sustainable growth, and a preference for more attractively valued segments that could benefit from improved consumer demand.
Japanese equities continued to deliver encouraging returns, supported by modest inflation, rising wages and ongoing reforms aimed at improving corporate governance and shareholder returns. While demographic challenges remain a long-term consideration and geopolitical tensions with China present a potential risk, Japanese equities continue to offer useful diversification and the potential for attractive long-term growth.
After several weaker years, Asian and Emerging Market equities performed much better in 2025, benefiting from a weaker US dollar and falling interest rates in developed markets. Valuations remain attractive in relative terms and the long-term structural growth story is intact, with these supportive macro factors likely to continue into 2026. The Chinese economy also appears to be regaining momentum, with advances in AI and electric vehicles beginning to show real progress. Despite the impact of trade tensions with the US, China is well positioned to benefit from companies and economies seeking to diversify supply chains. That said, Emerging Market investing (still technically including China) carries additional risks, particularly around transparency and data reliability, reinforcing the importance of accessing these markets through specialist managers and for investors to remain long-term and patient.
Fixed income markets were relatively stable throughout 2025, and our positioning for 2026 is likely to remain largely unchanged. Yields on high-quality bonds remain attractive, both as a source of income and as a defensive allocation should growth weaken. In a benign environment of steady growth and gradual rate cuts, we would expect fixed income to deliver reasonable returns, albeit lower than equities. Importantly, the role of bonds within a diversified portfolio is to provide protection during periods of economic stress, enabling investors to maintain exposure to higher-risk assets (i.e. equities) designed to generate long term growth across the market cycle. Consequently, we continue to favour government bonds and, selectively, investment-grade credit over higher-risk segments of the bond market, where credit spreads appear insufficient to compensate for higher levels of default risk. While lower quality bonds may offer marginally higher yields in positive markets, they are unlikely to provide meaningful protection in a downturn. Therefore, we still believe that active management remains crucial in balancing income generation with capital protection in pursuit of a properly diversified portfolio.
Alternatives and real assets continue to play a valuable role within portfolios. Gold’s run in 2025 was impressive, with the precious metal regularly reaching new highs with a combination of Central Banks diversifying dollar reserves and investors wrestling with growing political instability providing an environment for strong returns. Whilst there were a number of technical reasons for this rally in gold, investors must now consider how effective gold will be as an asset for risk mitigation with volatility gradually increasing as prices continue to rise.
As interest rate pressures have eased and balance sheets have stabilised following several years of restructuring, infrastructure and specialist property assets – the core of our alternatives and real assets investments – have benefited from improving fundamentals and renewed investor interest. Despite this, discounts to net asset value remain wide across many listed vehicles, offering the potential for additional returns alongside attractive income, as shares can be purchased at prices materially below the fair value of their underlying holdings. Carefully selected real assets should also continue to provide inflation protection and income stability within well-diversified portfolios.
In summary, the path through 2026 is unlikely to be smooth, however, fundamentals and history suggest that the best strategy is to stay invested. Equities remain the primary driver of long-term real returns, and periods of uncertainty have historically rewarded patient investors prepared to look beyond short-term noise. High-quality bonds, real assets and other defensive investments can play a crucial role in managing volatility, allowing us to maintain exposure to growth assets (equities) with confidence. We, therefore, believe that a disciplined, diversified approach combining selective equity exposure with resilient, high-quality defensive holdings remains the most effective way to navigate an uncertain world and capture opportunities as they arise.
*Source: FE Analytics, 05/01/2026
This note is intended as a general market update and should not be regarded as specific advice or treated as a recommendation to invest in any particular fund or asset class. Stock market investments can fall as well as rise. If you would like to discuss the implications for your own portfolio, please do get in touch.