Allocation Views: Rotation, momentum and geopolitical risk

Summary and themes

Our positive view of equities continues to be informed by resilient global growth and strong corporate fundamentals. However, geopolitical tensions caused by conflict in the Middle East have increased economic uncertainty.

Forecasting geopolitics is difficult and always requires a degree of humility, particularly in scenarios as fluid and fast-moving as the current Middle East conflict. We believe the most responsible decision as asset allocators is to curtail the tracking error in our portfolios and reduce equity risk, as we await greater clarity.

Disruption of energy supplies is the main reason for tension in financial markets, and Iran retains the ability to impede energy production and transit regardless of US military dominance.  If this continues, a prolonged surge in energy prices could raise inflation expectations, erode private sector confidence and slow economic growth.

Against this backdrop, we will be monitoring important energy, military, and diplomacy signposts to determine whether the conflict is de-escalating, before adding conviction. 

Absent any adverse effects from Operation Epic Fury¹, leading global economic indicators remain relatively healthy, amid expanding activity levels across manufacturing and services.

Technical market indicators offer support for a bullish view of equities, as previously stretched sentiment and positioning has normalized to more benign levels, but geopolitical uncertainty outweighs this for now, in our view.

Macro conditions continue to bolster corporate fundamentals, illustrated by our forecast of 11.9% for US earnings growth over the next 12 months. However, healthy earnings growth is disguising a bifurcation that has resulted in particularly challenging earnings expectations for large-cap growth stocks in 2026.

We mitigate this risk via bold changes to our intra-asset allocation, explained in this month’s Allocation Views.

Macro themes

A resilient growth story

• Leading economic indicators have strengthened, fueled by artificial intelligence (AI) capital expenditure (capex) and high-end consumers.
• Corporate sentiment appears strong, as evidenced by positive earnings revisions and guidance for calendar year 2026.
• The US economy has proven robust. Labor market data is disparate but remains stable.

Persistent inflation pressures

• Inflation remains above central bank targets in most developed economies, although inflation trends are still broadly disinflationary.
• Tariffs have been absorbed by both consumer prices and business margins. Core goods inflation remains above trend, albeit pressures may have peaked.
• Services inflation has eased due to lower housing costs and wages, although disinflation trends have slowed recently. Higher energy prices are a concern.

Policy bifurcation

• Fiscal policy in major economies is an increasingly influential driver of asset prices. US tax refunds will likely offset tariff headwinds, while stimulus measures in Japan and Germany could also prove supportive.
• Several major central banks remain in easing cycles, but the global policy environment has become increasingly bifurcated.
• Economic crosswinds, energy and geopolitics may prevent the US Federal Reserve (Fed) from meeting market expectations for rate cuts over the next year.
   

Portfolio positioning themes

Tactically neutral

• Forecasting geopolitics is difficult and always requires a degree of humility. As a result, we curtail the tracking error in our portfolios and reduce equity risk, as we await greater clarity.
• The macro backdrop remains supportive of risk assets, illustrated by positive leading indicators of economic growth and healthy earnings revisions and guidance.
• Sentiment and positioning have retreated to more normal levels, supporting risk assets and mitigating the ongoing valuations debate.
   

Rotating toward value

• We reassess our US equity positioning, initiating a preference for large-cap value stocks amid ambitious earnings expectations.
• We adopt an optimistic view of Japanese equities, leaning into market momentum, given an improved outlook for earnings and targeted fiscal stimulus. We downgrade UK and European equities.
• Earnings expectations are rising rapidly across emerging markets (EMs) ex-China, influencing our more constructive view on the region. We expect tailwinds from ongoing capital expenditure on AI hardware.
   

Neutralizing government bonds

• In Europe and the United Kingdom, we expect demand destruction to play a greater role in monetary policy decisions than inflation. Markets have overreacted to energy price concerns, in our view.
• Resilient US growth and sticky inflation is challenging market expectations for Fed easing. As a result, we stay underweight US duration.
• Fiscal deficits are widening in major economies, as governments increase spending or cut taxes to stimulate growth. Consequent yield effects make us selective on duration.