2025 has been a tremendous year for many investors. At the time of writing, most of the major asset classes have delivered very strong investment returns, with many stock markets reaching record highs.
Markets have been resilient through repeated shocks, not least Liberation Day in April. Some of the outcomes are surprising. Among equity markets, South Korea’s c.70% rise stands out, especially as the market narrative at the start of the year was focused on US exceptionalism. The S&P 500 Index rose but lagged many other markets, including the UK, Japan and emerging markets.
Despite buoyant markets, towards year end, a sense of unease has grown among investors. Elevated equity valuations, abrupt volatility in precious metal prices and worries over credit quality have been added to a list of existing concerns that included policy unpredictability and sovereign debt levels.
So what are we to make of the current investment backdrop? With the caveat that we can’t predict the future, what are the key issues that investors need to think about in 2026?
Valuations – boom or bubble?
One of the big questions investors are asking is whether valuations have become too elevated. The S&P 500 Index is currently trading on a 12-month forward price-to-earnings ratio of around 23, significantly above its long-term average of 16 times1. There are also concerns about valuations in the bond market, where credit spreads have narrowed near to their lowest levels in 20 years².
In particular, there are concerns that we might be in an AI bubble, inflated by soaring prices of AI-related technology and semiconductor stocks.
Whether we are in a boom or a bubble is hard to know. What is arguably more helpful is to try and assess the degree of optimism reflected in market prices and look for signs of emotionally driven behaviour: do we see fear of price declines or fear of missing out (FOMO)?
At present, investors appear focused on returns rather than worrying about the risk of loss. This suggests a degree of complacency.
This time is different
Today’s situation is often compared to the 1999/2000 dotcom bubble. My investment career started at the very end of the 1990s. At the time, it felt like a gold rush for internet stocks, most of which were deeply unprofitable. In that sense, today’s environment is definitely different: the companies at the centre of this AI story are reporting very strong revenue and earnings growth.
Recent commentary from a leading technology company suggests spending on AI will only increase in the years ahead, although as time passes investors will focus on whether such spending is generating a sufficient return on investment.
With considerable excitement about the potential of certain companies to make money from AI, there is scope for disappointment if some of the planned expenditure proves excessive or somewhat cyclical.
Although elevated asset price valuations do not necessarily signal a bubble, they could mean potentially lower future returns. There is also less compensation for risk if things do not turn out as expected.
In 2025, the best performing markets proved to be the ones that had low expectations at the start of the year. In 2026, could we see a similar pattern as investors seek to diversify beyond expensive AI stocks and consider more attractively valued stocks in the rest of the market or even look for value in regions such as Europe and emerging markets?
Central banks back in focus
AI has dominated investment discussions lately, but central bank policy is likely to become more important in 2026. Where inflation goes in the coming months will likely play a pivotal role for investment portfolios.
The market is expecting roughly 100 basis points of interest rate cuts in the US next year, despite a forecast that inflation will be closer to 3% than 2%3. If inflation data is problematic in 2026 then those rate cuts will come into question, which will pose a challenge both to bonds and equities.
If inflation remains persistently above the Federal Reserve’s (Fed) 2% target in 2026, while the labour market continues to weaken, policymakers may find themselves with a difficult decision.
Debt and deficits
The appointment of a new Fed chair next year could also influence the direction of interest rates. President Trump has repeatedly called for lower interest rates and he may use this opportunity to select a candidate who is aligned with his thinking.
Given the scale of the US government debt – over US$38 trillion4 – lower borrowing costs would make a significant difference to government finances. However, the US is not alone in facing budget pressures from deficits and ageing populations; France was in the headlines this year but most developed economies are grappling with rising debt levels.
This is arguably one of the reasons many investors are mindful of risk in government bonds. However, given that the real (inflation-adjusted) yields available on long-dated government bonds are more attractive than they have been in many years, might investors look more favourably on government bonds in 2026, especially if rates fall?
Resilience and diversification
There are plenty of challenges facing the world in 2026, but the global economy has shown resilience in recent years. The consensus among economists is for a year of moderate growth and inflation in 2026, although forecasts rarely play out as anticipated.
US economic growth is relatively solid, and the combination of lower interest rates and tax cuts from President Trump’s One Big Beautiful Bill could provide tailwinds in the year ahead. However, inflation, consumer confidence and employment trends will be things to keep an eye on in 2026.
Beyond the US, the German fiscal stimulus and increased defence spending could start to have a positive impact on the German and European economies. In Asia, countries, including China, will have to negotiate Trump’s trade policies, but unlike their developed counterparts they are not facing fiscal challenges.
Inevitably, there will be unforeseen events in the year ahead. However, there are reasons to believe markets can remain resilient but we may also discover if investors’ optimism is justified. In this complex environment, adopting a disciplined, diversified approach could potentially help investors find long-term value in the year ahead.
Importantly, investors’ success will likely be determined by how they react to surprises, rather than confidently predicting what may or may not happen.
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