Asset allocation update How we're thinking about markets...

Broad economic growth eased towards the end of 2025, although it remains at healthy levels with positive momentum. The outlook remains for growth in 2026 to be at or above trend, supported primarily by continued strength in the United States. The US economy is still benefitting from vast amounts of AI capital expenditure, falling interest rates and low unemployment, which could help offset the geopolitical turbulence emanating from the US.[1] A prolonged oil price rise could reduce economic growth through 2026 if we see significant supply disruptions.[2] Europe, UK and Japan are more exposed to rising energy prices as they are large energy importers.

Inflation continues to fall and is now almost in line with central bank targets. The exception to this is in the UK, where inflation, even though it has fallen, is still significantly above the Bank of England’s target. [3]  The increase in US tariffs has not had a meaningful impact on inflation in the US, however, a prolonged oil price shock could cause inflation in all regions to start picking back up, akin to 2022 when Russia invaded Ukraine.

Source: Saltus, Trading Economics

Fourth quarter corporate earnings results were robust. Corporates are still in a healthy position given resilient economies, positive consumers and rising wages. US technology companies were strong, but there was more dispersion between companies during this quarter, with the market starting to tire of the huge capital expenditure announcements. Looking forward, analysts expect healthy 19.6% earnings growth for global equities over the next 12 months. Regionally, Emerging Market earnings are forecast to grow quickest over the next 12 months, at 39.9%, with Asia ex-Japan corporate earnings also forecast to grow strongly at 38.9%. The UK and Europe have more subdued forecasts at 9.5%, and 11% respectively, but across the board the expectation is that 2026 will be another strong year for corporates. All regions are trading in line with their long term averages on a price to earnings multiple, except Emerging Markets and Asia ex-Japan which are trading slightly below. This consensus earnings and valuation data is taken from Bloomberg.

Market Themes

Dominating both financial and non-financial headlines is the conflict between Israel/US/Iran and the consequences for the energy market. We have discussed this in detail here Middle East conflict – market update | Saltus and we continue to monitor any impact on markets daily.

Below are a couple of other interesting market themes.

AI scare trade

Since mid-February, stock market sectors perceived to be vulnerable to AI-driven disruption have aggressively sold off.[4] This has been characterised as ‘sell now, ask-later’ investor behaviour, as rather than pick winners and losers, investors are indiscriminately selling their positions in the affected sectors.

The first sector to feel the wrath of the AI scare trade was software, in what is being touted as the ‘SaaS-pocalypse’.[5] Given the advances in AI tools that can write code, serious concerns have been raised over the core subscription models and pricing power of software companies. Popular stocks and indices in the sector have fallen between 20% – 30%, as investors work through the impact on individual companies’ business models from the new tools. This is made more difficult as more AI productivity tools are released each week.

What started in the software sector has spread to Wealth Management, as new AI-enabled tax and financial planning tools have been released. These are seen as providing routine tax and planning optimisation strategies more cheaply. Since then, Logistics, Cybersecurity, Consulting, Education, Property and Insurance have all been in the AI Scare Trade’s crosshairs. The market’s attention has shifted from the potential upside of AI tool providers to the impacted end users. There is a general feeling of negative sentiment around AI, and whilst these sectors have felt the blunt force of investor panic, it will be a while before businesses and investors have a clearer picture of which business will fail, and which will flourish as a result of these new technologies.

Equities

The committee decided to maintain the current regional equity exposures. Around half our equity exposure is in the US, which we consider to be underweight given the US dominance in the global stock market. The other half of our equity exposure is spread broadly, with notable positions in emerging and frontier markets, and Japan.

Within our US exposure, for the last two years we have purposefully sought to diversify away from the technology sector given valuation concerns, concentration concerns, and too much dependence on the AI narrative. At the recent meeting the committee decided to reduce our underweight to the US technology sector, but whilst still remaining under exposed. In the last four or five months, there has been a meaningful rotation away from technology and into the broader US stock market, which has benefited our positioning. The valuation premium of the technology sector has reduced, whilst the earnings outlook for the sector remains robust. The committee believes this provides a good opportunity to reduce our underweight position.

The committee also decided to alter the composition of our emerging and frontier market exposure. We are increasing our exposure to the emerging market index, and funding this from our active positions. The emerging market index has a significant allocation to Korea, Taiwan and China technology. These markets have suffered heavily in the past few weeks since the outbreak of conflict in the Middle East, presenting a good entry point to start building a position here.

The committee reviewed our exposure to Japan, Europe and the UK in light of current events, and were happy to leave these positions unchanged for now. The conflict in the Middle East is an ever-changing and fast moving picture. We are well positioned to move swiftly if required.

Bond

Within our fixed income exposure, we currently do not have a meaningful position in government bonds due to concerns around lingering inflation, fewer rate cuts, and the debt burden of developed economies. Where we do have government bond exposure, this is predominantly in UK gilts with a small holding in US inflation-linked bonds. The committee decided to reduce our exposure to the long end of the UK gilt market, reducing interest rate sensitivity. The long end of the UK gilt market has been strong recently, and we are concerned about the high level of correlation at the long end of government bond markets globally.

Within corporate bonds, we had exposure to both investment grade and high yield debt. Given the high valuation of investment grade bonds, or the narrow yield spread above government bonds, most of the returns in this asset class derive from the government bond yield element. Given we are wary of government bond exposure, the committee decided to reduce our investment grade bond holding.

The proceeds from both of these sales will be held in cash for now. This allows us to be opportunistic should we identify attractive investments in either bond markets, or other parts of the portfolio.

Alternatives and Currency

The committee made no changes to our alternatives or currency positioning.

Our alternatives exposures were analysed across four different themes.

1. Risk-off exposure – these positions should benefit from an increase in market volatility, especially on the downside. This includes traditional safe haven assets.
2. Absolute return strategies – these strategies aim to achieve positive returns regardless of market direction.
3. Alternative credit strategies – these target alternative parts of the credit market which have a low correlation to the wider market. These can include catastrophe bonds, trade finance and convertible bonds.
4. Risk-on exposure – these positions should benefit from a strong economy and rising markets but provide an uncorrelated source of return. This includes industrial commodities.

The committee are comfortable with our weighting across the four themes, given the diversification benefit they offer.

In currencies, we remain overweight in Japanese yen and Emerging Market currencies and underweight in the US dollar.