As we head into 2026 there is a lot of concern about equity market valuations. Comparisons are being drawn with the dotcom bubble of 1999-2000 due to significant investments being made by the hyperscalers into datacenters and cloud infrastructure. At the same time many AI start-ups are loss making, with their valuations being boosted by vendor financing. Against this backdrop we’ve heard talk about canaries in coal mines, cockroaches (where one emerges there are usually many) and staying at the party for one last dance.
But let’s leave analogies to one side and focus on our options.
Firstly, equity valuations are expensive. They have been more expensive in the past and are not at extremes yet, but you could argue for taking some risk off the table. For example, if you run a mature defined benefit pension plan, you might be able to accept a lower rate of return at this point and bank some profit.
Most investors are not in this camp, however. There are costs to sitting on your hands: inflation needs to be outrun to preserve the value of savings and, with limits on how much one can save, money has to be worked hard to deliver the funds required for retirement and other goals. You need a plan for the possibility that you could be waiting a long time for a correction and the golden buying opportunity.
The passive option is to stay invested in an equity index. Over the long term (20 years), history shows that equities deliver a decent return, particularly if fees are kept as low as possible to aid the compounding of those returns. The challenge with this approach is that, due to the concentration of equity indices in a small group of technology companies, you are particularly exposed to the equity valuations which everyone is so worried about. There is also significant idiosyncratic stock risk, if anything should go wrong with one of these large holdings.
I worry that not all investors realize how concentrated their exposure is. It is not always clear, in the case of passive investment, who oversees that risk for them.
Alternatively, you can try to risk manage the situation. As active investors, we take calculated risks based on a broad range of factors, knowing that over time our clients need a return. Looking at market valuations, we think that equity markets are still supported by the fact that bond yields are well-behaved, inflation is quiescent for now, and central banks are likely to ease a bit more. O Over the medium term, I am concerned about mounting government debt levels and the potential for inflation to accelerate, leading to higher discount rates, but over the next six months this risk is low. We also see low risk of US recession: although the labor market is softening, unemployment is still low and private sector balance sheets are in good shape. So, at market level, we still see positive returns from equities.
There is the question of stock-specific risk, which I raised above, but we still see the potential for the hyperscalers to deliver revenues. We are monitoring the return on investment of these mega cap companies as they have evolved from free cash flow monsters to big spenders, and we are also watching the performance of large language model and cloud computing companies as a reflection of the adoption of the new technologies.
The bottom line is that we still see opportunity at stock level. Critically, we take this risk deliberately, backed by detailed fundamental analysis, rather than because of the weight of a stock in the index.
Finally, we are finding opportunities for diversification. It hasn’t been all about AI. 2025 has shown the benefit of geographical diversification and Value has performed outside the United States. Emerging market debt offers better dynamics and higher real yields than developed market debt. There are also opportunities to generate income from diversifying investments such as insurance-linked securities and infrastructure debt. Liquid hedge fund strategies could also offer a means of increasing diversification whilst remaining invested.
As active investors, we don’t have the luxury of talking in vague terms about risks on the horizon. We have to take a view. For 2026, we see a low risk of recession, contained bond yields and momentum in company earnings which leads us to stay positive. Our processes are designed to recognize quickly if our views change or if we get it wrong, so that we can adapt and adjust our strategy.
The waters are getting choppier, but we still see ways of navigating them to get to our destination. It is too soon to seek shelter.
Read our full 2026 Investment Outlook
Author — Johanna Kyrklund, Group Chief Investment Officer
