Emerging markets become more attractive

The macroeconomic environment continues to support risky assets. Economic growth remains robust, profit margins are high, and earnings surprises have been positive. A solid jobs report in the US added to confidence that the world economy will continue to grow in 2026, avoiding a recession. Especially since President Donald Trump’s focus on affordability will likely lead to additional economic stimulus. Volatility did rise as investors increasingly looked at risks from AI spending.

Equity markets started the year on a divided footing. The US lagged while Europe and especially emerging markets performed well. The underperformance of the US is related to underwhelming returns of the IT sector, where software-related equities were hit by a double whammy of AI fears. On the one hand, high AI capex spending is weighing on the free cash flow that companies are generating despite growing profits. On the other hand, concerns emerged about the sustainability of software companies’ business models in a world where AI can become new competition quickly. In our opinion, the fear that AI will threaten or replace software companies is exaggerated and the market reaction as well. Additionally, the resulting regional differences in price momentum are more like a rotation between the regions than a signal that global risk is rising. Still, the waning momentum in US equities compared to other regions makes those regions look increasingly attractive.

Emerging markets, in particular, provide a combination of a resilient economic outlook, a stronger outlook for corporate earnings, solid price momentum and more attractive valuations for important sectors such as IT. Given the increased volatility and higher valuations in US IT equities, we see an opportunity to increase our exposure to emerging markets while decreasing our position in US equities. As a result, our position in US equities decreases from overweight back to neutral while our position in emerging markets increases from neutral to overweight. We also become slightly more positive about Europe although we still remain underweight on the region. Our broader view on equities remains positive.

Yields fell quite rapidly over the last few weeks, including at the longer end of the yield curve. A favourable US inflation report led investors to increase their rate cut expectations from the US central bank, the Federal Reserve (Fed). Meanwhile, the nomination of Kevin Warsh as the new Fed Chair may have led investors to price out a risk premium on yields as he was one of the more conservative potential candidates. However, given the strong macro-backdrop and the fact that yields already fell quite a bit and we see little opportunity for yields to fall further from here.

Meanwhile, credit spreads remained resilient despite volatility in other markets. Bond markets are absorbing new bond supply coming from big tech companies very well. The large IT companies are increasingly financing their AI spending with new debt. Investors appear largely unconcerned about their repayment capacity and instead focus more on the impact of those investments on their free cash flow. That also explains why recent market volatility has been contained to equity markets. The low credit spreads continue to support our view that high-quality (HQ) bonds are more attractive than high-return (HR) bonds since the added return does not provide sufficient compensation for the increased risk.

Even though credit spreads on investment-grade corporate bonds are low, spreads on covered bonds also declined substantially over the past year. As a result, within the high-quality bond segment, spreads on investment-grade corporate bonds have become relatively attractive. As companies stand to benefit from the improving macro climate, we believe it is justified to add some credit risk in our portfolios. We therefore increase our position in investment-grade corporate bonds from a practically neutral position to overweight, at the expense of covered bonds.

The economic outlook remains constructive while earnings growth expectations are positive as well. Therefore, we maintain an overweight position in equities. Regionally, however, we are adjusting our positioning. We are reducing our overweight position in the US back to neutral, increasing our position in emerging markets from neutral to overweight and becoming slightly more positive on Europe while remaining underweight on the region. Although the outlook for US equities remains solid, superior valuations and earnings expectations in emerging markets combined with volatility related to AI make emerging markets more attractive in the current environment. Additionally, we remain neutral on bonds, and we maintain a positive view on gold.

Richard de Groot 
Chair Global Investment Committee