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

The major economies continue to see positive economic growth, however, growth rates are slowing.[1] In the US, economic growth has exceeded expectations, with little negative impact from Trump’s tariffs evident so far.[2] Capital spending on data centres to enable AI models has driven a significant proportion of the growth. Following the longest US government shutdown in history, some key economic data for September and October is missing which makes forecasts difficult. In the other major developed economies, growth rates are slowing, having recovered through 2024. Expectations are for a continuation of this trend – slowing GDP growth, but not to recessionary levels.[3]

The picture is mixed on inflation. Headline CPI has been rising for the last four months in the US and is forecast to be over 3% by the end of 2025. Tariffs are expected to send inflation higher in the short term, but the impact should be temporary. The UK is also experiencing sticky inflation. UK headline CPI is almost twice the Bank of England’s 2% target. In Europe, inflation has been hovering around target for the last few months but has slowly started to move up again as we move towards the end of the year. Japan has had a much-needed reduction in inflation, and China is still battling with outright deflation.

Source: Saltus, Trading Economics

Third quarter corporate earnings results were robust. Corporates are still in a healthy position supported by 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 12.1% 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 17.5%, with Asia ex-Japan corporate earnings also forecast to grow strongly at 14.6%. The UK and Europe have more subdued forecasts at 8.8%, and 8.2% respectively, but across the board the expectation is that 2026 will be another strong year for corporates. These regions all trade in line with their long term averages on a price to earnings multiple, whereas the US remains overvalued. This consensus earnings and valuation data is taken from Bloomberg.

Market Themes

Dizzying heights

One doesn’t have to look very hard to find a stock market index that has hit record highs in 2025. So far this year we have seen a synchronised rally in the world’s major stock markets, driven by strong economic growth, a resilient consumer, falling interest rates, and more certainty over US trade policy.

In the US, all four of the major stock market indices have recently made new highs.[5] The S&P500, the Dow Jones Industrial Average, the Nasdaq 100 and the Russell 2000 have recently been in the record books, showing just how broad-based the positivity has been. We all know the story of US technology firms and their stratospheric growth, but the Russell 2000 is comprised of the smallest 2000 stocks on the market. These firms have rallied on the expectation of interest rate cuts from the Fed, as they tend to be heavily dependent on short term financing and so are particularly sensitive to prevailing rates.

In Asia, the dominant indices in Japan (Nikkei 225) and South Korea (KOSPI) have hit all-time highs, as well as the lesser known Singaporean Straits Times Index.[6] These have been driven by many of the same tailwinds. In South Korea especially, there is a large exposure to the AI theme through semiconductor makers. More on Japan below.

Closer to home, the FTSE 100, the DAX in Germany, and the CAC 40 in France have been riding high. At the European-wide level too, the Stoxx 50 and the Stoxx 600 have broken through previous peaks. The FTSE 100 is dominated by international companies, with a focus on commodity and pharmaceutical companies. Looking at the domestically focused FTSE 250 or FTSE 350, the gains have been nowhere near as impressive.

Interestingly, for all the AI-dominance headlines, the S&P500 has been one of the worst performing major stock markets this year.[7] A break from previous years of dominance.

Source: Saltus, Bloomberg (100 – 09/09/22)

Takaichi takes charge

At the end of October, Japan’s parliament elected the country’s first female prime minister, Sanae Takaichi.[8] The stock market hit record highs soon after as the market expects her pro-growth agenda to include easy fiscal policy, more defence spending, a revival of Japan’s nuclear power industry, and a preference for low interest rates.

On the other side of this, the Japanese yen weakened sharply, and government bonds sold off. The key for the yen will be if she can influence the Bank of Japan to keep rates low, but given the Bank of Japan is independent, this may not be the case. There is a strong relationship in Japan between the currency and the stock market. Historically, a weak currency has been a positive for the stock market, as Japan is an open economy dominated by exporting companies, who are helped by a weaker yen.

Takaichi is also expected to press ahead with the corporate governance reforms that have been taking place in Japan for a few years now. Japan has many listed companies, and they suffer from excessive capacity and competition. As a result, companies, especially small companies, are cheap.[9] Takaichi is expected to push on with reforms already in place to increase consolidation, shareholder returns, private equity purchases, and through this, valuations. We have long held a positive view on Japanese equities for a combination of an improving macroeconomic backdrop and corporate-level backdrop. Takaichi’s election has enhanced these views.

Equities

The committee was happy to leave the equity allocation broadly unchanged given their comfort with current themes and exposures. The equity allocation is currently balanced between US and non-US exposure, at almost 50/50. This is significantly lower than the global stock market, where US equities constitute 65% of the market.

Within our US equity book, we have a more diversified exposure, with less focus on the AI-driven companies. We have run our US equities like this intentionally for almost two years now, which in hindsight has been early, but we are comfortable with this due to concentration concerns. Going into 2026, the earnings and cash flow growth of these AI-driven behemoths will likely fall relative to the wider market, and investors are going to scrutinise the capital expenditure plans of these companies a lot more closely. Investors are going to want to start seeing a return on this investment.

In the other half of the equity book, we have a significant tilt towards emerging market equities (with a focus on Asia), frontier market equities, and Japanese equities. Emerging and frontier markets have some of the highest earnings growth forecasts, and lowest valuations of all regions. They are being supported by a weaker dollar, falling inflation, interest rate cuts, and more inter-region trade with China. As mentioned in the section above, we continue to have a positive view on Japanese equities, and our exposure here targets value stocks and small companies as we believe the potential upside in these areas to be significant. These positions make up around 30%, with the remaining 20% split equally between UK and Europe.

Bonds

We maintain a relatively low exposure to government bonds given debt concerns in a number of developed markets, combined with sticky inflation. Where we do have exposure, we are keeping our duration (interest-rate sensitivity) low to reflect these concerns.

Most of our government bond exposure is in the UK. We see the UK as ‘the cleanest dirty shirt’, given the focus on fiscal conservatism, and given that the bond market is quick to discipline the government’s spending intentions. The UK government relies on foreign investors to purchase its debt and doesn’t have the luxury of the US government whose debt is typically always in high demand. Therefore, the UK government must tread carefully, and it is also keen not to repeat the mistakes of Liz Truss. Even though the fiscal position of the UK government is weak, we are confident the government will make every effort to meet its fiscal commitments, which is positive for gilts.

In our US government debt exposure, we only have inflation-protected bonds, which have performed well recently, given the inflationary dynamics of the US economy.

In corporate bonds, we have minimal exposure to investment grade bonds. Given slim spreads (the extra yield above lending to the government), investment grade bond prices are heavily influenced by government bond yields, and we are nervous here. We continue to hold exposure to high yield bonds.

A bright spot has been our exposure to emerging market debt. We like this asset class given higher yields on offer, less debt sustainability issues, and tailwinds from a weaker dollar and looser monetary policy. Similar reasons to our overweight positioning in emerging market equities.

Alternatives and Currency

Within our diversified alternatives exposure, the committee decided to reduce exposure to UK infrastructure due to higher conviction in other parts of the alternatives book.

We maintain our positive view on gold, gold miners and copper. Copper is attractive currently given the long term demand dynamics, combined with the lack of investment in new supply. This exposure may also offer protection should we have a reflationary episode, where other parts of the portfolio may struggle.

Elsewhere in the alternatives book, we are increasing our exposure to the macro hedge theme. This is the part of the portfolio that should benefit from increased volatility in markets. An example of a fund we use in this space is given in the Fund in Focus section below.

The committee did not make any notable changes to our currency exposure. Our largest non-sterling active currency exposure is to the Japanese yen given the diversification benefit on offer. The Japanese yen tends to appreciate in times of market stress, giving the portfolio an element of downside protection.