Navigating markets: Opportunity and risk ahead

Strong market performance and improving sentiment is verging on exuberance in some sectors. Investors are confident that stretched valuations will be supported by economic resilience, a favourable policy outlook in the US and high levels of profitability. For now, conditions in equities are closer to a boom than a bubble, but we identify several areas to watch and have adjusted portfolios based on uncomfortable correlations between asset classes.

Momentum and outlook

Globally, equity markets have enjoyed a strong period of returns over the past 6 months, buoyed by evidence of resilient economic and corporate performance. As market attention turns to 2026, investors are placing confidence in the prospect of supportive fiscal and monetary policy in the US to enable equities to earn into their heightened valuations. Our view is that there are durable fundamental reasons for this good performance, but a familiar list of potential risks remains unresolved.

Economic tightrope

On the economic side is the tightrope between potential for a growth slowdown and the implications of sticky or even rebounding inflation. Aside from the usual considerations, unpredictable US policy could yet be the catalyst for either outcome, and international fixed income investors are still nervous about the outlook for weak public finances. Fears have subsided across the board, but this concern could spill over into broader market volatility.

The US government shutdown has created a void in economic data for the market to feed off. We expect the policymakers at the Federal Reserve to maintain their easing bias on interest rates through 2026 thanks to falling services inflation and subdued energy prices, but Chairman Powell’s recent message to stop the market getting carried away was clear: for an aggressive path on rate cuts, we’ll need to see continued labour market slowdown when the data-fog clears.

AI and trade

Within equity markets, key known risks are the concentration of the US market’s performance on the Artificial Intelligence theme and the potential for policy surprises to disrupt the outlook for whole sectors or countries. For now, it seems that investors have had enough time to digest both risks and grow comfortable with the range of possible outcomes. 

Extension of the volatility-free summer rally into November has been fuelled by optimism on US trade agreements across Asia. The implications for growth, inflation and profit margins are positive for US and Asian markets.

The aggressive capital expenditure on the infrastructure required for AI participation and the web of cross-investment among the major players has been a growing concern in 2025. Since ChatGPT broke into the wider market’s conscience in November 2022, the so-called hyper-scalers’ AI investment has mostly been funded by their unprecedented cash generation from ongoing operational earnings.

Given the capital expenditure shows little sign of slowing, investors are now paying more attention to funding. And to gauge whether the promise of the AI boom currently boosting US economic performance has transformed into a dangerous bubble, markets need to assess how and when the progress of transformational AI technology will translate into longstanding efficiency and profits for the tech companies and their customers.

Over time, it is likely the market will differentiate between AI winners and losers, creating volatility along the way. However, for now we believe a considered exposure to the AI ‘factor’ within the diversified Netwealth portfolios to be the best approach, given current momentum. Similarly, although it would be naïve to assume that the recent pronouncements on trade will hold for the duration of the Trump administration, recent negotiations should help to place a ceiling over trade friction up to the US midterm elections in November 2026.

Fundamentals vs valuations

After the strong run we’ve seen, valuation scores of the broader market have risen as many of the warier investors from earlier in the year have been lured back in. Considering a range of metrics, we can see markets are looking quite stretched, so there is less room for disappointment should the fundamentals falter. US shares have looked too expensive relative to their own history since early 2024, and relative to their international peers for longer.

The good news is that the outlook for corporate fundamentals remains robust. Companies are exceeding consensus market expectations for profitability around the world, and indicating to analysts that next year will be even better, sustaining earnings growth above 10% in 2026 and into 2027. Alongside the benign conditions created by supportive policy measures and cooling tempers on trade, valuation concerns feel surmountable for now.

Portfolio changes and positioning

When thinking of potential changes in the market’s appetite for risk, the Netwealth approach is not to try to predict, but to prepare. 

Our view remains that exposure to corporate earnings diversified across markets and sectors is the best way to build performance over time and we remain fully invested in equity allocations. However, as some economic concerns have faded, many of our allocations have performed well at the same time. The ‘everything rally’ has included our diversifying assets, which we worry has diluted their ability to protect portfolio performance in the future. 

We reduced our allocation to gold as it has shown signs of becoming a speculative asset in recent months, rather than a defensive one. The performance since our initial investment in 2021, when gold traded at $1,700 an ounce and real US Treasury yields were negative, has been extraordinary. This reflects valid investor market demand for insurance against the toxic combination of weak sovereign balance sheets, stubborn inflation and the potential of a regime shift away from dollar assets. However, with US Treasuries yielding close to 2% above expected inflation and gold at $4,000, the cost of future insurance has dramatically changed as so much fear is now priced in.

We also halved portfolio allocations in the two trend-following funds who have successfully leant into these positive market trends in equities and precious metals since the early summer. An unexpected re-evaluation of either market narrative could be challenging for them in the short-term; thereby amplifying, not diversifying market weakness.

We remain cautious on corporate credit where valuations suggest a level of complacency; if corporate yields remain well-behaved at these levels, we fully expect our equity holdings to deliver strong gains. We are pleased that our substantial allocations to cheaper international equities in emerging markets and Japan continue to make meaningful contributions to portfolio returns and have taken profits on the cyclical position in Korean equities.

Closer to home, the upcoming UK budget is keeping a firm lid on market and consumer confidence. We will be writing in greater detail on the market implications in due course. For now, we are not surprised to see markets interpret the outlook as one of slowing economic growth in the UK. Once the ‘event risk’ of the Budget has passed, it may pay to take a more optimistic domestic view.

Please note, the value of your investments can go down as well as up.