Global Asset Allocation: The View From Europe

Outlook

• We move to a slightly positive view across global risk assets. Despite extended valuations, earnings trends and economic growth remain favourable, with the latter supported by fiscal and monetary policies across most regions.
• US economic growth is bolstered by artificial intelligence (AI)-driven capital spending and supportive fiscal and monetary policies, although softening labour market trends remain a concern.
• Outside the US, the growth backdrop is broadly positive, with increasing fiscal support in several regions, including Europe and Japan. Lower inflation has allowed for monetary easing, helping economies offset the impacts of higher tariffs.
• Key risks to global markets include narrowness of AI trends supporting earnings and economic growth and markets, sticky inflation, potential for quickening labour market declines and ongoing geopolitical tensions.

Themes Driving Positioning

All the small things

Since April’s market low, small-cap stocks are outperforming large‑caps, with much of that coming recently with heightened expectations for a December rate cut. Small-caps have had several bouts of outperformance over the past few years but have yet to maintain a sustained edge over the might of the AI‑driven rally underpinning large‑caps. This time things may be aligning a bit more in favour of small-caps. Whilst they remain relatively attractive in terms of valuations, small‑cap earnings growth has lagged large‑caps, but that is expected to flip in 2026. Anticipated growth in capital expenditure , fiscal spending and easing regulations could drive small‑cap earnings and outperformance. Combining these tailwinds with additional US Federal Reserve (Fed) cuts should help ease refinancing concerns and support an acceleration in mergers and acquisitions (M&A) activity benefitting smaller companies. As we anticipate further market broadening in 2026, all the small things supporting small‑caps are starting to add up.

The great experiment

What had started in the US earlier this year over worries of uncontrolled fiscal spending and rising debt levels has made its way around the world, putting further pressure on long-term bond yields. The latest fears are playing out in the Japanese bond market over new Prime Minister Sanae Takaichi’s aggressive stance on fiscal policy aimed at stimulating growth and defence spending. The news has pushed Japanese long-end yields to multi-decade highs and the yen lower, further complicating the Bank of Japan’s path to normalisation.  Investors are cautiously watching this ‘fiscal experiment’ closely as Japan is already one of the most indebted developed nations, and piling on more debt at now higher borrowing costs is making this a costly bet. Whilst the hope is that these fiscal measures translate into a meaningful boost to economic growth, for now, the backdrop continues to warrant caution on long-term bond yields, not only in Japan, but across the globe. 

 

For a region-by-region overview, see the full report (PDF).