The bullish early bird may catch the worm, but we would rather be the second market mouse and get the cheese this year. Changing market leadership, complacent investors, inconsistent macroeconomic data and expensive valuations mean the Funds are positioned cautiously as we enter 2026. Our asset allocation is at the lower end of the allowable ranges. Our equity holdings are concentrated in a combination of lower-risk, higher-quality sectors. Our fixed income holdings are overweight duration, meaning they own longer-dated bonds in greater numbers than their benchmarks. After almost three explosive years for markets, during which our multi-asset funds materially outperformed both their passive benchmarks and active peers*, the overall beta of the portfolio, or market risk, is amongst the lowest it has been for a long time. We have materially rotated our positioning over the last three months.

The main source of underweight in the portfolio comes from our positioning in the US, and US technology names in particular. We took the difficult decision in early autumn to materially reduce exposure to almost all aspects of the AI theme. A brief recap from our Q3 outlook serves as a reminder of why we took this decision. This is speeding up the arms race for other hyperscalers and is also a problem. The current run rate of investment will see them invest ever-increasing amounts of their free cash flow into capex, and perhaps even have to resort to other forms of financing. The weight of this AI buildout may eventually begin to weigh on even the broadest of the MAG 7 share-price shoulders in the form of multiple de-rating. From hyper-scaling to hyper-spending. The risk profile of this capex cycle is therefore transforming from a public-market, cash-fuelled one to perhaps a private-market, debt-fuelled one. The implied capex, capital and power requirements for the latter half of this decade, following recent announcements, seem in the short term unobtainable and ripe for disappointment.

With the risk profile of these market generals changing, one naturally has to question the valuation premium the US market still enjoys. Entering 2026, the market is about as expensive as the S&P 500 has ever been at the start of a year. Current earnings growth will be strong, and further rate cuts are likely, but we would argue these are required simply to keep the market at current levels rather than act as new catalysts. It is surprising that, according to various market positioning indicators we follow, investors are carrying their lowest level of cash ever into 2026. This level of complacency belies the inconsistent and challenging macro and micro issues the market faces in early 2026. The performance of the regional darlings of 2025, emerging markets and Europe, was largely driven by re-rating rather than earnings growth, which feels difficult to repeat in 2026.

There is an inconsistency in the US economic data that gives pause for thought. The consumer slowdown is continuing and broadening beyond just the lower end, although it should be helped by a one-off, above-average tax refund season. Excess savings are now essentially depleted and back to pre-Covid levels, but net household wealth is at an all-time high. Unemployment is slowly drifting higher, although this may be driven by demographics and immigration policies. The jobs market is currently in a no hiring but no firing phase. While the financing and further acceleration of the recent capex boom is in question, the absolute level of spending is not, and should continue to keep GDP elevated. Even though leading economic indicators continue to show weakness, US GDP is likely to hover around 3 per cent for the first half of the year. There are no signs of credit stress in markets or bank earnings, although the shadow banking sector is showing alarming, if anecdotal, signs of strain.

The re-emergence of inflation as a political issue in the US at the end of 2025 was a classic example of Wall Street versus Main Street. Wall Street was encouraged by inflation of just 2.9 per cent, while Main Street was alarmed that the price level remains elevated above pre-Covid trends and is still rising at that rate. How this develops ahead of the mid-term elections could prove to be a key market catalyst. There may simply be insufficient political room for the new Federal Reserve Chair to cut rates as aggressively as President Trump would like, as any renewed inflation would risk severe electoral consequences for the Republicans. Ironically, a credible and independent Fed Chair could therefore become a headwind for market risk appetite. Recent polling suggests voters increasingly view inflation as the administration’s responsibility, with tariffs front and centre in that perception. The administration has quietly adjusted some of the more consumer-facing tariffs in recent months, and its response to the imminent Supreme Court ruling on tariffs will be closely watched. Equity markets have benefited from strong inflation and nominal GDP growth through higher sales, which has characterised the post-Covid investment environment. Continued disinflation and a more favourable rate backdrop should remain supportive, but only up to a point. Pricing power and margins may already be stretched beyond what consumers can absorb, leaving demand destruction and pockets of deflation, whether through overtly tight policy or a consumer-led recession, as key risks to elevated earnings expectations in 2026.

Another post-Covid risk that re-emerged in the latter half of 2025 is that of supply chains, particularly their weaponisation. Unprecedented price squeezes across areas ranging from metals to memory are likely to disrupt activity in early 2026. Many of these moves are policy-driven, reflecting the evolution of the tariff war into a broader trade conflict. While geopolitics has long been a widow-maker for equity investors, the recent escalation in global tensions is difficult to ignore. The US has blockaded Venezuelan oil, captured its leader and carried out strikes in Nigeria over the Christmas period. The conflict between Russia and Ukraine appears further from resolution than ever, Iran has resumed nuclear weapons activity amid widespread domestic protests, and China has conducted its largest-ever mock invasion of Taiwan. Offsetting this somewhat, the US appears to have relented by allowing Nvidia to sell high-end chips to China.

We are overweight long-dated bonds. Our concerns around fiscal sustainability have eased as western governments have shifted from attempting to borrow their way out of deficits towards taxing their way out. Recent developments in the UK and France suggest policymakers are keen to avoid a repeat of the Liz Truss-era bond market turmoil. While higher taxes to fund fiscal deficits, including via tariffs in the US, help stabilise bond markets, they create challenges for equities by weighing on growth and earnings at the margin. A global tax war could yet replace the trade war, with the US threatening to revive Section 899 measures first raised in early 2025. In addition, a global shift away from issuing long-term debt towards shorter-dated maturities, particularly in Europe, the UK and Japan, should support lower long-term yields as markets increasingly price in a slowing global growth and inflation backdrop. Long-dated bonds therefore look like a sensible starting position for 2026. In a low or falling inflation environment, the diversification and hedging benefits of bonds relative to equities should also reassert themselves.

We are overweight defensive and high-quality equities. While this positioning aligns with our macro outlook for the first half of the year, it is not the sole driver. These areas of the market currently offer the greatest stability of earnings alongside relatively attractive valuations. As the AI frenzy reached its peak, relative valuations and positioning in quality stocks fell to multi-year lows, creating compelling opportunities for our active, style-agnostic approach. We are overweight the UK and Europe, particularly banks and utilities, including both electricity and water. Water is a new theme within the portfolio, with exposure to US industrial companies across the full water lifecycle. In the US, we are overweight healthcare and software, with medical technology of particular interest this year. We have also built a basket of misperceived AI losers, high-quality companies that have experienced significant de-rating across sectors including financial services, publishing, consulting and software. Select areas of consumer staples also appear attractive, particularly those whose end markets benefit from the second-order effects of GLP-1 drugs and ongoing health and beauty trends. Subscription-based businesses, especially those that own valuable intellectual property, remain an overweight, as high-quality IP should become increasingly valuable in an AI-driven world. Finally, impressed by the resilience of traditional energy companies in maintaining, and in some cases growing, cash margins despite lower oil prices, concerned by the lack of a geopolitical risk premium in energy markets, and encouraged by the long-term potential of nuclear power, we also remain overweight the energy sector.

Written by Phil Byrne, CIO, Cantor Fitzgerald Asset Management

*Source: Moneymate & CFAM as at 31.12.2025.