A degree of caution after a strong start to the year

Markets had a positive start to the year, despite increased geopolitical risk, attacks on the Federal Reserve's independence, and persistent uncertainty about US trade policy. In January, the MSCI All Country World Index rose 2.9% in US dollar terms, driven by a nearly 9% gain in emerging markets.

Interestingly, small caps outperformed in the US market and value stocks continued their recovery versus growth stocks that began at the end of 2025.

The month saw unusual volatility in commodity prices, particularly precious metals and, to a lesser extent, industrial metals. The rally took gold, silver, and copper prices to new all-time highs, and fuelled a rebound in oil prices. This rise was triggered by geopolitical concerns following US military action in Venezuela, the conflict with Europe over Greenland, and the threat of intervention in Iran.

The Department of Justice's initiation of a criminal investigation into Federal Reserve Chairman Powell further raised concerns about the central bank's independence and risks to medium- to long-term price stability, contributing to the rise in government bond yields.

The nomination of Kevin Warsh as the next Chairman of the Fed after Powell's term ends in May has partially allayed these fears, leading to a rapid correction in commodity prices. The US dollar has also benefited, but despite the partial recovery, the decline since the beginning of the year has been almost 1.5% in tradeweighted terms.

Stock markets were supported by the solid global economic cycle and the prospect of Fed rate cuts later this year. Corporate profits have been revised upwards by analysts and are expected to grow by double digits for the second consecutive year in 2026. Nonetheless, global stock market valuations have become even more expensive, which warrants some caution.

To reflect these circumstances, we decided to take some profits after the stock market rally and increase cash in the asset allocation of a balanced portfolio. As a result, there remains a slight overweight in equities and a moderate underweight in fixed income assets and cash. Within equities, exposure to the US market should be reduced to neutral while adding to European equities and maintaining an overweight in emerging markets. Finally, we are cautious on the precious metals given the recent volatility.

Asset Allocation

Global Allocation

Equity markets have seen a strong start to the year and as a result market drift has pulled up our exposure. From this, we would like to take some profits and reduce our equity allocation, being positioned slightly more cautiously in case of a pullback. We still maintain a marginal overweight, given earnings momentum continues to be very strong; if we do start to see a divergence of messages from company earnings this could well be a catalyst to adjust positioning. This reduction will be balanced out with an increase to cash. With fixed income we will stick with market drift of an underweight position relative to the benchmark and alternatives is unchanged at a marginal overweight.

Fixed Income

Spreads remain tight and are likely to remain that way as economic conditions remain supportive. Nevertheless, within high yield bonds, greater diversification is needed so we have adjusted our preference to more global high yield rather than just purely US. As such, euro high yield is to be added to, moving from neutral to overweight, whilst US dollar high yield will be taken down from overweight to underweight. As highlighted in our Outlook 2026 we see opportunities in emerging market local currency bonds, due to relatively attractive real yields, particularly in Brazil, as well as benefits from a stable-to-weaker US dollar environment. We previously added to this exposure, and we are increasing our overweight allocation further. Hybrids have done well so we have taken a bit of money off the table to go further underweight. No changes are being made to our rates allocation, remaining positive overall, primarily in investment grade bonds.

Equities

For Asia Pacific equities we will stick with market drift which has seen a slight uptick, but not yet enough to go to neutral. Within the region, we are reducing the number of China A-shares, with signs of a weakening domestic economy and no concrete stimulus plans from the government. In contrast we are more positive on Hong Kong which should benefit from its technology weight in the index as well as some improvement in Hong Kong real estate pricing. South Korea is being added to having been very strong, moving up to neutral to reflect a risk-off mood. For India we are not adjusting our weighting, but owing to a decrease in the benchmark this is now at neutral. Latin America remains stronger so we are slightly adding to our overweight, whereas we are slightly cutting EMEA allocation, particularly oil-sensitive countries and those who have moved a lot in line with the gold price. As we look to turn a bit more defensive, we are adding to Europe, taking it to a marginal overweight whilst trimming back US exposure to neutral.

Equity Sectors

Equity Sector Views

UK
We have raised our exposure to materials and financials this year given more constructive supply/demand dynamics in commodities and our positive view on the outlook for cyclical risk. Conversely, we have reduced our energy holdings given our view of oil moving further into oversupply as we move through the year and reduced our positions in defensive quality holdings to fund our more pro-cyclical move.

We continue to see an opportunity for the outperformance of UK midcaps over the coming quarters, reversing a multi-year period of underperformance due to high inflation and interest rates, both of which are now expected to normalise. Information technology has been a sector in which we have found specialist UK companies trading on attractive valuations in our view backed by strong structural growth tailwinds.

US
Cloud and AI investment continues to grow unabated. Healthcare was previously added to, as political uncertainties ease and US onshore investment picks up. Here we continue to remain cautious on managed healthcare instead focusing on pharma and healthcare tools. We are positive on financials, as net interest margins expand and investment banking activities increase, with focus on banks rather than insurance. We also remain positive on consumer discretionary, due to the wealth effect, potential rate cuts and a tax refund bump in early 2026. While we are looking for opportunities to buy industrials it is still too soon.

Europe
This month energy is being increased on account of geopolitical risk and the associated move up in oil prices, rising to a slight overweight. This is being funded by a further reduction in communication services, where many stocks are performing poorly on concerns around disruption from artificial intelligence. Previously materials exposure had been reduced to an underweight, as a result of competitive pressures from China.

Alternatives

Commodity exposure remains underweight, maintaining gold as our only exposure. However, there is a degree of caution on the precious metal owing to its recent strong rally. Nevertheless, if gold exposure is being used to hedge-out geopolitical risk it would make sense to maintain an allocation as a source of insurance rather than taking profits. Our overweight towards insurance-linked securities (ILS) had been increased in recent months. This was because relative to hedge funds there is a skew for yields and in the current environment, we do not see hedge funds outperforming ILS. Hedge fund positioning is held as an overweight, with the hedge fund team having a positive outlook on discretionary macro and commodity trading advisers.

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