Macroeconomics and Markets: The Investment Implications

1. Our base case: Mild US recession, tepid global growth

Our central scenario anticipates a shallow US recession, driven by tariffs and immigration policy as well as increased unemployment. We expect modest Federal Reserve (Fed) easing in this environment. Meanwhile, the eurozone and Japanese economies are expected to accelerate from increased fiscal stimulus. China may encounter stable to slightly lower expansion, as fiscal spending is offset by property-sector headwinds. The UK is prone to experience flat or slightly dampened growth, supported by accommodative monetary policy. Emerging-market economies, particularly in Asia, are positioned for a boost, benefitting from a weaker US dollar and favorable regional dynamics.

Investment opportunities:

• Equities:

  In this scenario, we favour developed markets ex-US, especially the eurozone and Japan. Fiscal stimulus will likely generate positive momentum, and these stock markets benefit from relatively attractive valuations.
  
  UK equities could also perform well. The region offers relatively low valuations, high dividend yields and elevated buyback yields. Expectations are modest given investor trepidations about the UK’s fiscal headwinds; this offers the potential for positive earnings surprises – especially if monetary policy eases further.
  
  There may be an upside for Chinese technology (‘tech’) stocks within this landscape, given their lower valuations relative to US tech stocks, as well as the Chinese government’s policy support for certain industries within the tech sector.
  
  In terms of style, Quality is likely to be rewarded, given growing concerns about a rise in artificial intelligence (AI) spending-related debt, and given softer global growth. Against this backdrop, we find stocks with strong balance sheets appealing.

• Fixed income:

  We prefer European investment grade, as well as European high yield debt, as we anticipate a positive growth backdrop in the eurozone.
  
  We see potential for a gradual steepening of the yield curve, lending itself to shorter duration positioning.

• Currencies:

  In this eventuality, the Japanese yen and the euro are likely to strengthen versus the US dollar, given expectations that the Bank of Japan will tighten its accommodative monetary policy stance, and the European Central Bank will maintain interest rates at current levels.

• Alternatives:

  We favour equity market neutral strategies, given the potential for both selloffs and rallies over the course of the year.
  
  We also like diversified multi-strategy portfolios given the uncertainty and potential for market rotations during the year.
  
  We are positive on selective private credit, which tends to perform well in volatile market environments and can offer diversification benefits.
  
  We have a preference for precious metals that also have industrial uses, such as gold, silver, palladium and platinum, which can represent 'safe haven' assets during selloffs, but may also benefit from their pro-cyclical exposure during market rallies.

2. Downside scenario: Policy errors and AI capex stall

Policy errors, coupled with a major drop in artificial intelligence (AI) capex investment, could push the US into a relatively deep recession. The Fed is unable to cut interest rates because of persistent elevated inflation. The economic downturn is softened for economies undergoing substantial fiscal stimulus such as the eurozone, Japan and China. 2026 becomes a ‘risk off’ environment.

Investment opportunities:

• Equities:

  In this outcome, we prefer select large-cap equities in defensive sectors such as consumer staples and regulated utilities.

• Fixed income:

  We favour inflation-protected securities, which are likely to perform relatively well in a higher inflation setting. We also like sovereign debt with high credit ratings, which seemingly offers resilient potential in the face of a major economic downturn in the US.

• Currencies:

  We expect ‘safe haven’ currencies to perform relatively well in this scenario. However, not all are certain to remain as such. We hold a preference for the Swiss franc, the Japanese yen and the euro, and are more cautious about the US dollar, given some erosion in confidence.

• Alternatives:

  We view gold as a ‘safe haven’ asset that is likely to hold up well in a ‘risk off’ environment.
  
  We believe trend-following strategies and volatility risk management strategies are attractive as they can typically offer downside protection against a tumultuous backdrop.

3. Upside scenario: Capex supercycle and détente

Trade wars end and artificial intelligence (AI) capex investment continues to increase. Emerging-market economies, including China and India, see an acceleration in growth. The eurozone and Japanese economies also see a lift in gross domestic product. The US experiences a modest pickup in growth as the Fed eases. 2026 becomes a “risk on” environment.

Investment opportunities:

• Equities:

  In this outcome, emerging-market Asia stocks, including Indian and domestic Chinese stocks, appear attractive; we expect Chinese tech and US tech stocks to perform well. European cyclicals are well-positioned to benefit. In addition, we are positive on global small- and mid-cap stocks.
  
  We think cyclical sectors, such as industrials; materials; energy services; semi-conductors/ semi-conductor capital equipment; shipping/ logistics; and selective financials appear attractive, in this circumstance.

• Fixed income:

  We believe global high yield bonds and emerging markets bonds (preferably ‘hard currency’) are appealing. These assets have historically performed well in ‘risk on’ environments. We would see value in emerging-market local currency debt, if real interest rates rise and credible disinflation is underway.

• Currencies:

  We favour commodity-exposed currencies, such as the Canadian dollar and the Australian dollar, which are likely to outperform in a ‘risk-on’ environment, given increased demand for industrial commodities when economies are growing.

• Alternatives:

  Industrial commodities and energy present interesting opportunities. These assets typically see significant price increases when economies expand.
  
  In this scenario, trend-following strategies would likely allow investors to robustly participate in a ‘risk-on’ setting.