Talk of an asset market bubble is intensifying. However, we believe this equity market rally is backed by strong earnings growth and cashflows and, therefore, it still has legs. High valuations are evident across equities, credit and precious metals. Therefore, we believe investors need to access as many sources of diversified returns as possible to ensure they set up for long-term stability and growth.

There is clearly a tug-of-war of narratives as we head into 2026. The optimists argue we remain in a bull market supported by strong earnings growth, easing financial conditions and growth supportive policies. Pessimists argue that valuations are stretched, inflation is stubbornly high, especially in the US, and it is only a matter of time before fiscal challenges result in higher bond yields, undermining support for equity markets.

Why we remain optimists

On balance, we side with the optimists. While the current AI theme is in some regards reminiscent of the ‘dot com’ theme of the late 1990s, there are two key differences in our mind. First, in the late 1990s, there was a clear decoupling between the relative performance of tech sector equities and earnings growth. This has yet to happen today, with the tech sector outperformance warranted by the strength of earnings.

The second reason is that the amount of investment in AI is significantly lower as a percentage of economic activity relative to previous boom cycles. Therefore, we still see the AI investment-led economic recovery as having some way to go. Of course, this does not preclude the risk that we are in the process of blowing a bubble, but we do not think we are near the end of that process. Equity markets typically do very well in the final years of the boom.

That said, we cannot ignore the fact that valuations are elevated, and in response, we have three key strategies that can help manage the risk of significant volatility in 2026.

Diversification strategies to manage risks

First, diversification within equities. We note there are a lot of investors who have a high exposure to the US technology sector. This comes from two key sources – a) the high weight of the US tech sector within benchmarks due to the sector’s outperformance over the past 10-plus years and b) the fact that technology always has a strong narrative, and we all like a good narrative when it comes to investing.

We believe proactively managing this concentrated exposure to technology is just good risk management. Therefore, we advocate diversifying both geographically and sectorally within equities. Geographically, we balance our overweight US positioning with an overweight to Asia ex-Japan equities, which should benefit from a weaker USD, policy stimulus in China and India, and exposure at lower valuations than in the US.

Sector-wise, we marry our global overweight to technology with overweights to the global healthcare sector (particularly US pharmaceuticals), utilities in the US, industrials and financials in Europe and communication services in China.

The second strategy is to diversify income sources within portfolios by overweighting Emerging Market (EM) government bonds, both USD-denominated and local currency bonds. In our opinion, EM bonds offer attractive credit quality as fiscal fundamentals improve, a higher yield than their Developed Market equivalents and exposure to non-USD currencies and interest rate cutting cycles.

Embracing alternatives

The final strategy is to diversify into alternative asset classes. We remain bullish on gold. Central banks remain a source of strong demand for gold as they try to diversify away from their reliance on G3 government bonds in their FX reserves. While central banks are price sensitive to some degree, survey evidence indicates that they remain keen to increase their gold reserves, putting a rising floor under prices, in our opinion. We forecast gold hitting USD 4800/oz in 2026.

We also look to allocation in other areas of alternatives. In private markets, we continue to believe private credit is an attractive area. While there are some initial signs of deterioration in credit quality, we believe private credit is still cheap relative to public credit markets and therefore warrants an allocation. While much of the focus is on the US private credit space, we believe private credit in Europe is particularly attractive. Meanwhile, private real assets – both real estate and infrastructure – are also interesting in a world where credit conditions are loosening and US inflation remains relatively elevated.

Hedge fund strategies are also a potential area to diversify into. We believe equity long-short and event-driven strategies are the most attractive spaces in a world where equity markets are expected to continue to do well and mergers and acquisitions activity is on the rise, aided by easing monetary policies and tight credit spreads.

The final area to consider is digital assets. We have added a small allocation to digital assets in our Foundation+ asset allocation models for 2026. While this is still a nascent asset class where the returns, volatility and correlations with other asset classes are likely to evolve over time, we see a small allocation of around 2% balancing off the potential returns and risks going forward, especially after the correction experienced in the end of 2025.

New year, new concerns, new opportunities

There is uncertainty about the outlook for financial markets as we head into the New Year. This time last year, the concern was about how Trump’s aggressive tariff policies would affect equity and bond markets. However, our view that the “Trump-put” (i.e. President Trump would ease policies if markets react too negatively) would dominate was prescient. After a sharp post Liberation Day sell-off, equity markets recovered as Trump backtracked.

This year, the concern is valuations. Our central scenario is that this may result in bouts of greater volatility, but it will not be enough to constrain equity markets in 2026 as long as earnings continue to deliver. However, this is not a time for riding with the stabilisers off – anything but. Therefore, we believe diversification across asset classes, geographies and sectors will be more important in 2026 than in any other year.