The implications for public equity indexes are meaningful. Together, these companies are expected to list at a combined valuation approaching $4 trillion, more than the total amount raised in all IPOs during the entire dot-com era. While the initial free float for each is likely to be far smaller, ¹ index requirements have either already been waived, or are likely to be waived, so these firms could enter major indexes relatively quickly. Over time, as floats and index weights increase, OpenAI and Anthropic would further expand the large weight of technology in public benchmarks, while SpaceX could blur traditional sector lines across industrials, communications, and technology. Their addition could also make expensive parts of the market look richer still. None of the three companies are yet profitable, and SpaceX’s targeted $1.75 trillion valuation would equate to roughly 100x its 2025 revenues.

Public market investors will gain access to the leading artificial intelligence (AI) franchises and the dominant private space and satellite communications platform. But by the time these companies list, much of the earliest and most explosive upside may already have accrued to private investors. That points to how the financing model for innovative companies has changed. Previous generations of high-growth firms often went public relatively early to fund expansion; today’s largest private companies can remain private much longer because they have access to enormous pools of capital. OpenAI raised more than $120 billion in a private round earlier this year, and Anthropic is reportedly raising about $30 billion privately. As a result, these IPOs are not just about raising capital but also about providing liquidity, establishing transparent price discovery, and broadening the shareholder base. Public markets are no longer the first engine of scale for companies like these, but they remain the main venue for liquidity, governance visibility, and wide ownership.

These offerings could affect the broader IPO market by drawing capital away from other new issues. While Anthropic has not yet filed, SpaceX and OpenAI are each rumored to be seeking at least $60 billion in IPO proceeds, more than double the previous US record set by Alibaba in 2014. In any issuance window, investors have finite risk budgets, portfolio capacity, and attention. Offerings of this size could dominate the calendar and lead investors to fund participation by trimming allocations elsewhere. Even so, Goldman Sachs expects total equity issuance in 2026 to be around $600 billion, including IPOs, which would still amount to less than 1% of US equity market capitalization. That suggests the broader market should absorb these deals without major dislocation, even if they temporarily crowd out smaller offerings.

For venture investors, the implications are more nuanced. Successful IPOs could boost fund-level marks and eventually help convert paper gains into realized distributions, though liquidity may be more gradual because initial floats are small and, at least in SpaceX’s case, tiered lock-ups would make some future sales partly dependent on stock performance. Because funding in these companies has been so concentrated, their IPOs could further widen the gap between top- and bottom-performing venture funds, reinforcing the importance of manager selection. They may also influence future capital deployment by requiring some funds to cast a wider net. Five companies, including OpenAI and Anthropic, accounted for more than 80% of US venture funding in first quarter 2026. Subject to tax and cost considerations, some investors may wish to consider hedging arrangements for what may end up being outsized single positions. For taxable investors specifically, there may be additional options to diversify risk and offset or defer taxes, including direct indexing or extension strategies.

Overall, these mega-IPOs matter less because of the immediate size of their public floats than because of what they signal about valuation, liquidity, and capital formation. Their small initial floats should limit near-term market impact, but their rich valuations raise the risk that public investors gain access only after much of the upside has been captured privately. And while the offerings are likely to be digested by the overall market, their prominence may crowd out other issuers in the near term. For venture investors, that creates both tailwinds and headwinds: stronger marks, realizations, and distributions for the best-positioned funds, but also greater concentration risk and a tougher environment for other portfolio companies seeking to go public.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post Do Mega-IPOs From Companies Like SpaceX, OpenAI, and Anthropic Mark a Changing Relationship Between Public and Private Markets? appeared first on Cambridge Associates.

That concentration risk is visible in the structure of the global equity market. US equities now account for roughly 64% of the MSCI All Country World Index, up from 42% in 2010, while the top ten US companies make up about 25% of the benchmark. Information technology holds a peak 37% share of the S&P 500, above late-1990s levels. These figures show that market leadership remains unusually concentrated, even as leadership has spread to a wider set of AI-linked beneficiaries.

The earliest winners, semiconductors and hyperscalers, were joined in 2024 by memory producers, data center providers, digital infrastructure firms, electrical equipment manufacturers, industrial companies tied to power build-out, and some utilities. Recent results underscore this expansion. Both Samsung and SK Hynix benefited from rising demand for high-bandwidth memory and related AI-linked memory products in first quarter 2026, and electrical equipment suppliers reported strong order growth linked in part to data center demand. Utilities and power-related firms have also participated as investors seek exposure to AI-driven electricity demand. AI remains a capital-intensive build-out that ties a growing share of market leadership to the same investment cycle.

The hyperscalers remain central to that cycle and may be more vulnerable than markets assume. Markets have not fully rerated hyperscalers for a business model that is becoming far more capital intensive. Combined capex for Alphabet, Amazon, Meta, Microsoft, and Oracle is estimated at roughly $760 billion in 2026, with cumulative property, plant, and equipment (PP&E) potentially approaching $2 trillion by 2030. On a five-year depreciation schedule, that translates to about $400 billion of annual depreciation expense, roughly equal to their combined 2025 profits. Markets may be underestimating the earnings growth and monetization required to justify such capital intensity, particularly in a market segment where enthusiasm and fear of missing out have often pushed equity prices ahead of fundamentals. Leadership that depends on companies becoming more asset-heavy, financing-dependent, and execution-sensitive is less secure than it appears.

If AI economics disappoint or investment slows, the impact could ripple across multiple market segments that now appear diversified. Essentially, hyperscaler capex is driving much of the market earnings and price momentum in ways that make the entire market edifice dependent on spending by five hyperscalers. For example, Empirical Research Partners finds that a basket of 48 large-cap stocks benefiting from AI spending has outperformed the broad market by 174 percentage points since the start of 2024. Spanning semiconductors and related equipment, capital equipment, metals, utilities, and tech hardware, the basket has accounted for 42% of market returns over the last 12 months and is expected to contribute nearly half the market’s earnings growth this year. While leadership has broadened in one sense, continued strong performance is dependent on the capital spending of a narrow set of companies. And if their capex should continue at such a frenetic pace, it becomes more challenging for these companies to earn the high returns on invested capital (ROICs) that market valuation multiples demand.

There is also an important distinction within the expanding beneficiary set. Some adjacent beneficiaries, especially at the intersection of AI and electrification, may prove more resilient than pure AI plays. Grid modernization, transmission, electrical equipment, and certain utilities enjoy support from multiple demand drivers, including industrial electrification, energy security, and broader infrastructure needs. AI helps these areas, but it is not their sole source of support, making their return outlook less tightly bound to AI monetization than that of hyperscalers or direct AI plays.

The practical implication is that investors should focus on how many truly distinct drivers of return a portfolio contains. When a single secular story drives equity concentration, capital spending, credit issuance, infrastructure demand, and venture enthusiasm at the same time, the case for diversification becomes stronger, not weaker. Investors need not reject AI, but they should recognize that the better long-term opportunity may lie in markets where expectations are lower, valuations are less demanding, and portfolios are less dependent on a single story. AI has made concentration more diffuse and stealthier, but it has not made it less risky.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post Has Artificial Intelligence Made Market Concentration Less Risky? appeared first on Cambridge Associates.

Today’s market leaders remain strong businesses, but they are also priced for a continuation of unusually favorable conditions. Meanwhile, valuation gaps across regions and styles are wide; inflation risks are less settled; and the geopolitical, policy, and fiscal backdrops are less benign than investors had come to expect. In this edition of VantagePoint, we explain why investors should be wary of relying on rearview mirror assumptions, where current concentrations create the greatest vulnerability, and why more attractive opportunities now lie beyond the market’s recent winners. The implication is not to react abruptly, but to act strategically.

Investors are not prepared

At the end of every bull market, investors tend to be overallocated to whatever worked best. Today, that means not only US equities and US dollar assets, but also a US market that has become unusually concentrated. The United States now represents roughly 64% of the MSCI All Country World Index, up from about 42% in 2010, and the top 10 US companies—most of them technology related—account for 24%. The information technology sector is near its 36% share of the US market reached earlier this year, exceeding the concentration seen in the late 1990s, and that doesn’t even include Amazon, Alphabet, Meta, and Tesla, which are classified as consumer discretionary and communication services stocks. Foreign capital has been attracted to US assets, supporting the US dollar. As was the case in the 1990s, once the enthusiasm for US equities fades, the US dollar will likely fall as well.

US household equity ownership has also risen to unusually high levels relative to net worth, with equities exceeding real estate by the widest margin in the post-World War II era. Previous episodes in which a narrow group of companies came to dominate market returns—including the Nifty Fifty era in the late 1960s/early 1970s and the dot-com era of the 1990s—proved poor moments to abandon diversification. The point is not that these exposures are about to collapse. It is that many portfolios now rest on assumptions that have become less reliable.

Most investors have correspondingly little direct exposure to tangible assets with real-world scarcity value. That mix made sense in a world shaped by falling inflation, expanding globalization, and stable supply chains. It makes less sense in a world where supply constraints, geopolitical friction, and higher capital intensity are becoming more persistent features of the investment landscape.

The supply side of the economy has changed in ways that look more structural than cyclical. In just five years, investors have had to absorb a series of major shocks: the COVID-19 pandemic, Russia’s invasion of Ukraine, US tariffs, and now the Iran War. Each has reinforced the same lesson. Inflation is not simply a demand-management problem, and geopolitical risk is not a remote tail event. It is a recurring influence on growth, prices, capital flows, and investment priorities. Geopolitical rivalry, defense modernization, artificial intelligence (AI) adoption, energy security, and climate change mitigation and adaptation are increasingly moving together, with important consequences for capital spending, inflation, and asset returns.

This is the rearview mirror problem. Investors are still using the conditions that shaped the past 15 years as a guide for what comes next, even as that backdrop becomes less dependable. We made a similar point in early 2000, when we warned that apparent diversification had been undermined by a shared dependence on US technology exposure. The parallel is not exact, but the lesson is familiar: portfolios built around what worked in one regime can become more fragile than they appear when conditions change.

AI is eating the world, at a cost

AI is the most powerful expression yet of a much longer cycle of US tech leadership. What began as a market preference for scale, duration, and capital-light growth, evident in the earlier dominance of the FANGs (the popular acronym for Facebook, Amazon, Netflix, and Google first coined in 2013) has evolved into a dependence on a small group of companies tied, directly or indirectly, to the AI buildout. Their influence now extends well beyond equity benchmarks. AI-related spending is helping to drive corporate capex, support economic growth, shape investment-grade debt issuance, and increase demand for electricity generation, transmission, and grid resilience. As in past booms, a single theme has grown large enough to shape multiple parts of the investment landscape at once.

That broader reach is one reason historical parallels are useful. Major technological revolutions have repeatedly followed a familiar path. Railroads, electrification, and the internet all produced real economic transformation. They also produced overbuilding, excessive optimism, and eventually some form of bubble dynamic. That is not a contradiction. It is often how transformative technologies are financed. Capital rushes toward the most visible opportunities, investors assume early leaders will capture most of the value, and markets discount a future that proves harder, more competitive, and more capital-intensive than expected. There is little reason to expect AI to be different.

The late 1990s offer a particularly useful comparison. The problem then was not simply speculation. It was that market leadership, capital spending, financing activity, and investor expectations became tightly bound to a single secular narrative. Many dot-com companies were highly speculative and unprofitable, with Pets.com serving as a useful poster child for the era. But companies like Cisco, Microsoft, and Oracle were real companies with strong businesses and central roles in the digital economy. The lesson is that even genuine technological leaders can become poor investments when valuations imply too smooth a path from innovation to durable returns. The same risk exists today.

Recent market weakness has taken some of the air out of the most stretched valuations, although much of the improvement has been retraced in April’s sharp market rally. Forward earnings multiples for the Magnificent 7 are meaningfully below their peaks. And on sales-based measures, the derating has been less pronounced, suggesting that investors are still paying demanding prices for a narrow set of companies expected to deliver an unusually large share of future growth. Some froth has come out of the market, but it remains heavily dependent on continued execution from the same leadership cohort.

The financing side of the story deserves at least as much attention as valuation. Hyperscaler capex has risen sharply even as free cash flow has started to decline from 2024 peaks, narrowing the gap between internally generated cash and the spending required to maintain leadership. Indeed, these companies are expected to spend $700 billion on capex in 2026—a 70% increase over 2025 spending, which will eat into free cash flows even as operating cash flow is still rising.

As that gap closes, debt financing—including off-balance-sheet structures—is becoming more important. The breadth of the theme is visible in private markets as well. AI and machine-learning deals accounted for roughly half the value of global venture capital investment in 2025 and are expected to account for an even larger share in 2026, up from about one-fifth in 2020 and almost nothing in 2010. That is another sign that AI is no longer simply one promising area of innovation. It is increasingly the organizing principle for capital formation across the growth ecosystem. That may create important opportunities, but it also reinforces the need for discipline. When one theme absorbs such a large share of capital, the line between durable advantage and speculative excess becomes harder to draw.

Just as important, the market may still be valuing some of these companies as if they retained the economics of capital-light software businesses. History suggests caution. Firms that grow assets aggressively have tended to underperform more capital-efficient peers, a pattern consistent enough to be embedded in academic factor models. If AI leadership increasingly requires sustained investment in data centers, chips, power, and networks, some of today’s leaders may deserve a different valuation framework than the one investors have become accustomed to applying. Consider that if current analyst estimates are correct, the hyperscalers will have accumulated $2 trillion in AI-related assets by 2030. Assuming an average life of five years, or 20% depreciation, would result in $400 billion in annual depreciation charges, roughly equaling their combined profits of $405 billion in 2025. The AI cycle is moving from enthusiasm to financing, and markets may still be underestimating the eventual cost of leadership.

The investment risk, then, is not simply that AI enthusiasm has gone too far. It is that many portfolios are more dependent on a single theme than they appear. When one secular story drives equity concentration, capital spending, credit issuance, infrastructure demand, and venture enthusiasm all at once, the case for diversification becomes stronger, not weaker. Investors do not need to reject AI to recognize that the better long-term opportunity may lie in markets where expectations are lower, valuations are less demanding, and portfolios are less dependent on a single story.

Credit as an early warning system

Credit deserves attention because it often reveals fragility before equity markets do. The signal today is mixed. Traditional default rates in public credit have eased, and reported defaults in private credit appear to have eased as well. But broader measures that include distressed exchanges, liability-management exercises designed to avoid default, and payment-in-kind restructurings paint a less comfortable picture. Headline default rates still look manageable, but they may understate where strain is building. That is especially true in private markets, where quarterly marks, amend-and-extend activity, and abundant capital can delay recognition of weakening credit conditions.

AI adds another layer to this picture. As the financing cycle has progressed, more of the capital required to support AI-related investment has moved beyond equity enthusiasm and into credit markets. Investment-grade credit is expected to see gross supply rise about 25% this year to a record $2.25 trillion, with a 10x increase to an estimated $400 billion coming from hyperscalers and related infrastructure. Structured credit markets are expected to see data center securitizations rise by nearly 50% to $30 billion. That includes financing for data centers, infrastructure, and businesses whose economics remain unsettled. It also matters for software-heavy loan books, where some of the most aggressively structured deals were made in businesses that now face greater competitive pressure or pricing uncertainty as AI diffuses. Parts of the market are now being tested against assumptions formed in a more benign period.

Credit market structure has also changed materially over the past decade, with important implications for who provides financing, where leverage sits, and how stress could spread through the system. Private credit is now a much larger and more influential part of the financing ecosystem than it was a decade ago. Much of that growth reflects tighter bank capital regulation after the Global Financial Crisis (GFC), which made some forms of lending less attractive for banks and created room for private lenders to expand. Investor capital followed, drawn by higher yields and the promise of illiquidity premia. This shift brought real benefits, including broader access to capital and more flexible financing for some borrowers. But it also intensified competition, particularly in direct lending, where spreads are tight and lender protections have weakened in more crowded parts of the market.

The same shift was reinforced by the long period of near-zero interest rates that followed the GFC. Zero Interest Rate Policy (ZIRP) did not just lift asset prices. It also encouraged financing structures and underwriting assumptions that were easier to sustain when capital was cheap, and refinancing was routine. Highly levered companies, aggressive growth strategies, and buyouts struck at elevated multiples all looked more manageable in that environment. Many businesses will prove less resilient in a higher-rate world, especially where earnings growth is slowing, equity cushions are thinner, and valuations remain anchored to a more forgiving era. The clearest pressure point is the cohort of loans originated in 2021, when financing terms were exceptionally easy, equity valuations were overstated, and leverage was often pushed to levels that are harder to refinance today. That matters for private equity as well as private credit and secondary funds that are picking up these companies as they come to market. Some of the most vulnerable credits are direct loans tied to sponsor-backed transactions completed when financing was abundant.

The main risk is not necessarily systemic in the way investors associate with 2008. But the warning is still meaningful. Pockets of strain in credit reinforce the broader message of this note: portfolios built around a narrow set of favorable assumptions may be more fragile than they appear. A slowdown in private credit lending would still amount to a form of credit contraction, potentially weighing on growth and certainly increasing the cost of the AI buildout. Risk to the banking system is limited for now, although bank exposure to the private-credit ecosystem has grown and available data almost certainly understate the full extent of those linkages. Insurance is another area to watch, particularly, if private-letter credit ratings overstate underlying credit quality. In such circumstances, highly levered, thinly capitalized insurance companies that have accumulated too many direct loans may come under pressure. Recent concern has also centered on semiliquid vehicles that offer more liquidity than the underlying private credit assets they hold. These funds have seen increased retail outflows, raising the possibility that stress may emerge through gating, valuation uncertainty, or a more selective and uneven availability of credit rather than through a single market-wide break.

For investors, the takeaway is not to avoid credit, but to recognize that portfolios built with disciplined manager selection, underwriting, and fund structuring during more exuberant periods should be better positioned to navigate market shifts. Diversification across sub-strategies should also provide ballast to portfolios.

Where to look for diversification

Investors should respond by trimming crowded exposures and rebuilding diversification. The most compelling opportunities now lie in areas where valuations are lower, expectations are less demanding, and return drivers are less tied to the same crowded narrative. That points first to non-US equities, value, small-cap equities, active strategies including hedge funds, and real assets tied to a more capital-intensive and electrified economy.

The strongest public market opportunity is outside the United States. Non-US equities offer lower valuations, less concentration, and greater exposure to sectors and styles left behind during the long period of US large-cap dominance. A weaker dollar, which we expect, would provide an additional tailwind for non-US equity exposure. The combination of valuation support and currency tailwind has historically been a powerful setup for extended periods of outperformance. Global ex US equities are also tilted to traditionally value-oriented sectors, which adds to their appeal in the current environment. The broader capex cycle now underway, while still tied to AI, also incorporates more geographically dispersed themes of energy security, grid resilience, and defense, providing additional support to non-US markets with deeper exposure to industrials, utilities, and related cyclicals.

Small-cap equities also look more attractive than they have for some time. Relative to large caps, valuations are modest, and earnings expectations are beginning to improve as growth broadens beyond technology-related winners. Small-cap equities, especially in the United States, have been held back by higher financing costs, weaker balance sheets, and the market’s overwhelming preference for scale. But that is also why they offer greater upside if capital becomes more selective and market leadership broadens.

Near-term risks remain. Global ex US equities and global small caps are more exposed than US large caps to economic disruption tied to conflict in the Middle East, and the dollar could strengthen further in the short run. But the situation is too fluid to time tactically. Investors are better served by rebuilding diversification and using periods of renewed dollar strength and US equity outperformance to add to non-US positions and reduce US dollar exposure.

A less concentrated market would also improve the opportunity set for active management. The dominance of large-cap equity performance has created a powerful headwind for active managers. Broadening market leadership and ebbing concentration would change that. Within hedge funds, the case is strongest for strategies that benefit from greater dispersion rather than broad market direction. Equity long-short managers should have a better opportunity set in a world where valuation matters more and returns become less concentrated. This may be particularly fruitful in less efficient markets outside the United States. At the same time, less directional hedge funds, such as arbitrage, global macro, and trend-following strategies can help diversify portfolios when stock-bond relationships become less reliable and macro shocks reverberate across markets in less predictable ways. Other diversifying strategies, such as insurance-linked securities and asset-backed credit can also provide diversification. These are not perfect hedges, but they are better suited to a more fractured environment than portfolios that rely on cash and sovereign bond duration as their only ballast.

Real assets should also play a larger role, especially the resources and infrastructure needed to support a more capital-intensive and electrified economy. Electricity infrastructure and grid modernization are among the most compelling structural opportunities in real assets. The International Energy Agency estimates that $600 billion per year in grid investment is needed by 2030, roughly double current levels. The AI buildout, reshoring, and the energy transition are all increasing demand for generation, transmission, storage, and grid efficiency. The Iran War reinforces the strategic value of energy security, resource independence, and AI-related capabilities, all of which are increasingly being treated as matters of national security. These are long-duration needs with real economic importance and, in some cases, attractive supply/demand characteristics. For portfolios that have become too dependent on financial assets and intangible growth, this is one of the clearest ways to rebuild exposure to scarcity value and real-economy investment.

Commodities and natural resources offer some inflation sensitivity and exposure to supply constraints, though timing has been difficult, particularly given weakness in the Chinese economy and property sector. Years of underinvestment in mining and extraction have created meaningful supply deficits in copper, lithium, nickel, and uranium. The structural case is strong, but current pricing already reflects some of that scarcity even as Chinese demand remains soft. Should the tail risk scenario of the Iran War push the global economy into recession, valuations in parts of the complex would likely become more attractive, creating better entry points and reducing the timing risk that has frustrated investors in this space. Investors should approach this opportunistically, building positions when prices allow rather than chasing what has already moved.

Private markets also require more discrimination. Venture capital is likely to produce some of the future winners in AI, and investors who want exposure to that upside will need some exposure to the private ecosystem. But this is still an early-stage technology cycle, and the eventual winners are far from settled. Investors should be careful not to confuse access to the theme with access to the returns. Meanwhile, many existing technology investments, especially enterprise software deals struck when rates were near zero and valuations were generous, are being tested in a more demanding environment of higher rates and AI disruption. Because private commitments are long-lived, pacing matters as much as manager selection. Investors should continue to allocate to private investments selectively, with patience about timing and valuation rather than rushing to add exposure simply because a theme is compelling. If a new wave of eagerly anticipated technology initial public offerings (IPOs) comes to market this year (e.g., SpaceX, Anthropic), investors should be measured in redeploying capital to private investments, balancing those opportunities against other parts of the market offering more attractive valuations and differentiated return streams. Especially in AI- and software-focused private equity, investors should favor managers with valuation discipline, rigorous underwriting, and the ability to distinguish durable advantage from enthusiasm financed on easy terms.

In short, portfolios built with too much concentration in prior winners are increasingly fragile. We cannot know precisely when leadership will change, but we do know that portfolios are more resilient when they are not built on the assumption that the recent past will continue indefinitely. We believe the strategic response is clear: trim crowded exposures and rebuild diversification through non-US equities, value, small-cap equities, real assets, and active strategies that can benefit from greater dispersion. Investors do not need to abandon the market’s recent winners. They do need to stop treating them as the only place to look for durable long-term returns.

Drew Boyer and Justin Hopfer also contributed to this publication.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post VantagePoint: The Rearview Mirror Problem appeared first on Cambridge Associates.

That broadening is already evident in market performance. Returns have become less dependent on a narrow group of mega-cap US stocks, and leadership has continued to widen across regions and capitalizations. Building on its strong outperformance in 2025, the MSCI ACWI ex US Index outperformed the MSCI US Index by another 460 basis points (bps) year-to-date. Smaller-cap leadership has also strengthened: the S&P 600 Index has outpaced the MSCI US Index by roughly 850 bps year-to-date and remains ahead over the last 12 months.

The macro backdrop continues to support this shift. Growth remains modest but is accelerating across many regions, helped in part by rising fiscal support. Germany is the clearest example, where defense spending alone could total €650 billion between 2025 and 2030, double the level of the previous five years. At the same time, longer-term inflation expectations remain well anchored and have not moved enough to alter either the growth outlook or our broader asset class views. In Japan and Korea, continued progress on corporate governance reform should further support earnings quality, capital allocation, and shareholder returns.

Against that constructive backdrop, the Iran War still presents meaningful near-term risks. The key concerns are oil supply disruptions, shipping bottlenecks, and firmer inflation expectations. While the ceasefire extension is an encouraging sign against further escalation, Iran’s continued closure of the Strait of Hormuz to most international traffic keeps these risks elevated. Even so, a limited flare-up would most likely result in only temporary volatility and a brief increase in oil prices. A broader conflict involving additional state actors or a prolonged disruption to strait transit would require a more fundamental reassessment, particularly if it led to sustained shipping disruption, persistently higher oil prices that fed into core inflation expectations, or tighter financial conditions that began to undermine growth. We view that outcome as unlikely, given the incentives of all parties to avoid it.

On balance, that leaves the case for non-US equities intact. The macro environment remains supportive, and valuations continue to provide an important cushion. The MSCI ACWI ex US Index trades at roughly 13.7x forward earnings, a discount of about 30% to the MSCI US Index’s 20.0x multiple. That valuation gap should remain supportive if market leadership continues to broaden beyond the most expensive segments of the US market.

At first glance, stronger 2026 US earnings growth estimates (19% versus roughly 14% for the MSCI EAFE Index) may seem to challenge that view, but the gap overstates the breadth of the US advantage. Much of the projected US growth remains concentrated in the heavily weighted information technology and communication services sectors and, beyond that, in a small number of companies. The Magnificent 7 are expected to account for more than 40% of the S&P 500 net income growth in 2026, and more than half of the roughly 3 percentage-point rise in bottom-up S&P 500 earnings growth forecasts since late February came from a narrow cluster of companies, led by Micron Technology and several large-cap energy names. That concentration creates meaningful single-theme execution risk tied to artificial intelligence–related capital spending. Any moderation in that cycle—whether from weaker demand, regulatory constraints, or renewed capex discipline—would likely weigh more heavily on US earnings than on peers. By contrast, global ex US markets have less exposure to those narrow leadership groups and a more diversified earnings base overall, and they should also benefit as marginal flows from foreign investors into US assets make up a smaller share of total cross-border allocations, reducing an important source of relative support for US equities.

Similar logic supports our preference for developed markets small caps over large caps. Valuations remain attractive: the MSCI World Small-Cap Index trades at roughly 16.1x forward earnings versus about 18.2x for the MSCI World Index. At the same time, small caps do not require giving up earnings growth. The 12-month expected forward earnings growth for the MSCI World Small-Cap Index is 18.2%, above the 16.7% for the MSCI World Index. In other words, small caps offer a more attractive valuation entry point alongside slightly stronger earnings growth expectations, a combination that should prove supportive if leadership continues to broaden beyond the narrow group of mega-cap winners that has dominated recent years. In the United States specifically, small caps should also benefit from their relatively large industrial exposure, given ongoing support from the 2025 One Big Beautiful Bill Act and the 2021 Infrastructure Investment and Jobs Act.

In sum, while the conflict has increased near-term sensitivity to energy and inflation shocks, it has not undermined the broader case for continued equity market broadening. That view is still supported by the same forces that were in place before the conflict: improving relative valuations, more favorable earnings breadth, and a macro backdrop consistent with wider market participation. Our tilts toward non-US equities and developed markets small caps remain grounded in those dynamics, which we believe are still fully intact.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post Does the Iran War Change Our View That Equity Market Broadening Will Continue? appeared first on Cambridge Associates.

The coordinated attacks on Iran by the United States and Israel, which began on Saturday, February 28, have jolted markets, with the clearest effects showing up first in energy. Tanker traffic through the Strait of Hormuz, a critical passage for about 20% of global oil and liquefied natural gas (LNG) supply, has dropped sharply. At the same time, production across the region, including in Iran, Kuwait, Iraq, Saudi Arabia, the United Arab Emirates, and Qatar, has also been disrupted. Because oil demand is relatively insensitive to price in the short run, even modest supply losses can push crude prices meaningfully higher. That dynamic helped drive front-month ICE Brent futures up 46% from when the conflict began to $106 per barrel in trading today, prompting G7 countries to consider releasing petroleum from their strategic reserves and renewing concerns about inflation.

Many economists estimate that a $10 per barrel increase in oil prices would add roughly 15 to 30 basis points to US headline inflation. On that basis, a sustained 50% rise in oil prices could add about 0.5 to 1.0 percentage point (ppt) over the following year. The incremental inflation pass-through from further oil price increases may also diminish at higher price levels and over time as demand weakens. The impact on core inflation, which excludes food and energy prices and matters more for monetary policy and asset prices, would likely be much smaller. This is because energy is often only a modest input into the cost of goods and services relative to labor and other expenses, and firms may absorb part of the increase in margins rather than pass it through fully to consumers. The broader impact is also likely to be more limited than in the 1970s, when economies were far more energy intensive. In fact, in many advanced economies, energy use per unit of output has fallen by more than half since then as efficiency has improved.

Still, the inflationary impact will not be uniform across countries and regions. Economies that are net importers of oil, LNG, and other affected goods such as fertilizer are more exposed. In Europe, for example, prices for a key natural gas benchmark rose 67% last week, compared with an 11% increase in the United States, even though supplies from the Middle East account for only about 5% of the EU’s combined LNG and pipeline gas imports. Similar dynamics have played out in parts of Asia. For many non-US energy importers, the challenge could be compounded by the tendency of the dollar to strengthen during periods of market stress, which raises the local currency cost of dollar-priced commodities such as oil and LNG. Taken together, the hit to headline inflation in some non-US economies could be meaningfully larger, perhaps twice that of the United States. But, as in the United States, the effect on core inflation would likely be more limited for the same reasons.

Of course, the impact of the conflict on inflation will depend largely on its duration and scope. President Trump has sent mixed signals on how long it could last, at times suggesting it may end within weeks and at others that it will continue as long as necessary, likely as part of a pressure campaign aimed at securing a deal. Even so, he appears to prefer a short conflict. He has long criticized the protracted wars in Iraq and Afghanistan, and a prolonged campaign would raise the risk of greater US casualties, backlash from some Middle East allies, and higher inflation, all of which could weigh on political support at home ahead of the November congressional elections. That helps explain the administration’s move to support the war risk insurance market, which could limit further disruption to shipping flows if the conflict remains contained. Longer-dated oil & gas prices in both the United States and Europe likewise suggest investors expect the conflict to subside rather than become prolonged.

Even if the conflict were to last longer than most expect, the inflation backdrop would still differ markedly from the one that produced the pandemic-era surge. That episode reflected an extraordinary combination of fiscal and monetary stimulus and severe supply constraints, especially labor shortages. In the United States, annual inflation rose by 8.8 ppts, from 0.2% in May 2020 to 9.0% in June 2022, an increase comparable in scale to the major inflation episodes that peaked in 1974 and 1980. By contrast, today’s inflation risk is more concentrated, with higher energy prices rather than a broad-based demand and supply shock serving as the main transmission channel.

The conflict is likely to reinforce this year’s existing rotation within equity markets. Energy and industrial equities could benefit further as investors place a higher premium on sectors tied to commodity supply, defense, and industrial capacity, while the risk of firmer inflation may limit central banks’ willingness to cut rates, creating a less supportive backdrop for rate-sensitive growth sectors such as technology. We expect this dynamic to continue supporting our July 2025 recommendation to tactically overweight Latin American equities within emerging market portfolios, given the region’s significant valuation discount and more moderate, though still present, exposure to geopolitical risk. Across geographies, US equities may continue to benefit in the near term from safe-haven demand. Over time, however, the broader aftermath of the conflict could support greater marginal flows to ex US assets, consistent with the trend evident earlier this year, as some investors reconsider the risks of concentrated exposure to US assets and the dollar amid greater policy uncertainty and elevated valuations.

More broadly, periods of heightened geopolitical risk are a reminder of the value of diversification and discipline. As we noted in our 2026 Outlook, investors that have allowed their equity allocations to drift higher over the last decade or two should evaluate increasing their policy exposure to diversifying strategies such as hedge funds, given the broader shift in the risk-reward profile across asset classes. While markets often recover quickly from geopolitical shocks, the case for diversifying strategies is particularly compelling today relative to broad equities, which remain expensive, unusually concentrated in a small number of names, and less geographically diversified than is typical. Put differently, today’s environment calls for portfolios built to withstand a wide range of outcomes.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post Will the Iran Conflict Trigger a Pandemic-Style Inflation Spike? appeared first on Cambridge Associates.

The election results represent a resounding win for Takaichi, with the LDP alone winning a two-thirds supermajority in the Lower House. Together with their coalition partner, the Japan Innovation Party (JIP), Takaichi now effectively controls 76% of Lower House seats. While the LDP does not have a majority in both houses, the Lower House supermajority enables the LDP/JIP coalition to override any opposition from the Upper House.

Takaichi secured the election by pledging decisive leadership and a vision for a more self-sufficient and assertive Japan, while also addressing the country’s cost of living crisis. Opinion polls consistently indicate that inflation is the most pressing concern among voters. With the electoral mandate, Takaichi will be able to press ahead with planned reductions in consumption taxes, expand household subsidies, and implement strategic investments and reforms in sectors such as semiconductors, shipbuilding, and AI. Additionally, increased defense spending looks likely. All in all, fiscal spending may increase by 2%–3% of GDP.

While fiscal stimulus may boost near-term growth, which has helped Japanese equities outperform global equities by 6 percentage points this year, increased government spending comes with its own risks. Notably, Japanese bond and currency markets were initially spooked in mid-January following the announcement of the snap election, reflecting concerns about debt burdens, political pressure on the Bank of Japan (BOJ), and the prospect of higher inflation.

Fiscal crisis concerns, while relevant, are overblown. Japan’s debt-to-GDP ratio has been declining in recent years, and interest expense as a percentage of GDP is lower than in other developed countries. Additionally, foreign ownership of JGBs is relatively low, reducing the likelihood of a sudden fiscal crisis or a “Liz Truss moment” similar to what the United Kingdom experienced in 2022. The recent rise in Japanese bond yields has been driven by rising inflation in Japan and reduced bond purchases by the BOJ, which has sought to shrink its balance sheet. With core inflation running close to 3%, real interest rates in Japan are still low, which is partly why the yen remains under pressure.

Tackling cost of living concerns ultimately requires a stronger yen, as a weak yen is partly to blame for inflation pressures. The Japanese government has made it clear that it will intervene if the USD/JPY exchange rate approaches the 160 level. But such a level will be hard to defend in the absence of higher interest rates. Given the election all but guarantees increased fiscal stimulus, the BOJ will need to continue hiking rates, otherwise, it risks a further rise in inflation.

Continued BOJ rate hikes, combined with modest rate cuts by the Federal Reserve, would further narrow the yield gap between Japan and the United States, providing support for the yen. Additionally, higher government bond yields in Japan could prompt the repatriation of some Japanese overseas bond holdings, exerting further upward pressure on the yen.

Overall, we see the election outcome as positive for the Japanese economy and, by extension, the yen. To capitalize on this outlook, we favor strategies that are less sensitive to JPY appreciation. Specifically, we like Japanese small-cap equities, which are a significant component of our current tactical recommendation to overweight developed markets small caps, as well as private equity buyouts and activist strategies. These strategies are well-positioned to benefit from stronger domestic growth and the ongoing momentum in corporate governance reforms and merger & acquisition activity within Japan’s market.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post Japanese Election Result Should Boost the Economy and Ultimately the Japanese Yen appeared first on Cambridge Associates.

by Thomas O’Mahony

Global ex US equities have outperformed US equities by 4.4 percentage points (ppts) in local currency terms so far in 2025 and by 11.2 ppts in USD terms. We believe that conditions are in place to see that outperformance trend continue in 2026 and we recommend that most investors modestly overweight global ex US equities from US equities. This view is founded on attractive relative valuations, improving regional growth catalysts outside the United States, and rising concentration within US equities.

There are two facets to the valuation proposition of overweighting global ex US equities from US equities, the first of which is the still-elevated valuation of the US dollar. As detailed earlier in this outlook, we expect the dollar to decline further in 2026. Despite some depreciation in 2025, the dollar remains 32% above its median real valuation based on current equity weights. While a declining dollar does provide some earnings uplift for US equities via the translation impact on their non-US earnings, the overall net impact should still be a headwind for the performance of USD-denominated assets when translated into other base currencies.

The second leg of the valuation argument rests on the historically rich relative valuation of US equities. As of the end of November, the cyclically adjusted price-to–cash earnings (CAPCE) ratio of the MSCI US Index was 2.2x greater than that of the MSCI ACWI ex US Index, representing a 50% premium above their long-run median relative valuation. Of course, a portion of this is attributable to the greater weight of more profitable tech stocks in the US index, which justifies a higher valuation. However, the broad valuation point remains valid even when looked at from an equal-sector weighted basis, whereupon the relative CAPCE is 25% higher than its median value. Valuations are powerful predictors of returns in the long run. Though their usefulness in forecasting short-run returns is weaker, they nonetheless succinctly express where pockets of both opportunity and risk may lie.

The global ex US category is not, of course, a monolith, but rather a diverse grouping of countries with distinct drivers. In Europe, while underweights to the high-performing IT and communications services sectors were a headwind to performance, financials—the region’s largest weighting—outperformed every sector of the ACWI. This outperformance was significantly aided by rate cuts delivered in the region and the resultant steepening of yield curves. Nonetheless, a significant valuation discount persists versus the United States. With lending data to both the household and corporate sectors picking up, this outperformance should have further to run in 2026. Indeed, the intention of Germany, Europe’s recent laggard, to materially increase fiscal spending should lift all boats to an extent in 2026, even as certain peripheral economies, such as Spain, have performed strongly.

Meanwhile, in Japan a coordinated push for enhanced corporate governance is ongoing, led by the Tokyo Stock Exchange (TSE). Its initiatives emphasize improving capital efficiency, pushing companies with low price-to-book ratios to disclose credible improvement strategies, and unwinding legacy cross-shareholdings. This has prompted an increase in shareholder returns through share buybacks and dividends. Concurrently, the nation appears to be emerging from its multi-decade disinflationary environment, with a virtuous wage/price dynamic gaining traction. This, alongside a tight labor market, is bolstering nominal wage growth, providing a tailwind for domestic consumption and nominal equity prices. Expectations of further fiscal easing from new Prime Minister Sanae Takaichi should also support these themes.

Emerging markets (EM) economies stand to particularly benefit from a continued decline in the dollar. A weaker greenback generally eases EM debt burdens, creating space for governments to use fiscal policy to support growth. Stronger local currencies also curtail imported inflation, allowing domestic central banks to run less restrictive monetary policy. Emerging markets should also benefit from a likely continued, if gradual, decline in trade tensions.

The earnings per share (EPS) growth of the US equity market is on course to thoroughly outstrip that of most other global equity markets in 2025, aided especially by the growth generated by the Magnificent 7 companies. It is perhaps unsurprising that a wide valuation differential can persist in such an environment. However, if the currently forecasted convergence in EPS growth rates across regions occurs in 2026, valuations outside the United States will look much more appealing by comparison and price pressures will emerge to narrow the value gap. EPS growth in 2025 also highlights the potential vulnerability of US equities to weakness in the tech sector (and tech-adjacent industries), with concentration risk having increased significantly, as discussed earlier in this outlook. As a result, earnings disappointment could result if headwinds impact just a handful of firms. Furthermore, the exposure of US equities to a narrow slate of sectoral drivers, particularly the AI story, increases the idiosyncratic vulnerability of the index to a dampening of enthusiasm toward that theme.

Of course there are risks surrounding this view. In the first instance, it could transpire that the US economy proves more resilient than we expect. Secondly, leading US companies in high-growth industries could maintain strong financial and competitive positions, particularly if optimistic projections regarding AI adoption are validated, attracting further investor capital. Nonetheless, we view the cumulative probability of these scenarios as being less likely than the alternatives. As a result, we expect global ex US equities to outperform US equities in 2026.

Investors should overweight developed markets small-cap equities in 2026

by Sean Duffin

Both US and non-US DM small-cap equities are positioned to outperform their larger-cap counterparts in 2026, supported by a convergence of attractive valuations, solid fundamentals, and favorable macro and policy dynamics—though the relative influence of these factors varies between the two blocs.

The outlook for small-cap equities is shaped by several key macroeconomic trends, most notably the ongoing realignment of the international trade order. The US tariff policy introduced in 2025 has primarily affected trade between the United States and other countries, rather than trade among non-US economies. The United States now runs an average effective tariff rate of 17%, compared with a rate around 2% at the start of 2025. With these barriers in place, small-cap companies in non-US markets may be better positioned to grow earnings, as their limited reliance on US consumers makes them less vulnerable to the potential negative effects of US tariffs than their large multinational counterparts.

Recent and ongoing policy actions further bolster the case for small-cap equities. In the United States, anticipated policy rate cuts could loosen credit conditions, benefiting small-cap companies that typically carry more debt than large caps. Newly enacted tax legislation—including more favorable interest expense deductions—could also support small-cap earnings. The 2025 One Big Beautiful Bill Act reverts the interest expense deduction calculation to EBITDA for all companies subject to the interest limitation rule, allowing most US small caps to deduct more interest expense. While the bill also raises the small business exemption threshold, this exemption applies only to the very smallest firms and does not affect the majority of US small-cap stocks, which are much larger by revenue. Efforts to revive domestic production may also favor small caps, depending on the success of these initiatives.

Outside the United States, recent policy initiatives also look supportive. In Europe, fiscal stimulus measures—such as those passed into law by Germany earlier in 2025—are expected to boost domestic demand and support smaller companies. Japan, which has a sizable number of small-cap companies, is implementing major industrial policy initiatives, including the Green Transformation plan and strategic support for semiconductors and supply chain resilience, and could also benefit from its shift to a more pro-business leadership regime.

Small-cap equities in both the United States and developed markets outside the United States are also trading at multi-decade discounts relative to mid- and large-cap peers, based on normalized price-earnings ratios. Despite these steep discounts, small-cap companies have not experienced the kind of fundamental deterioration that would warrant such low valuations. In fact, small caps have delivered resilient earnings growth compared to large caps, particularly outside the United States. Looking ahead, consensus estimates point to a meaningful acceleration in small-cap earnings growth across regions in 2026 and 2027, outpacing their larger-cap counterparts. This robust outlook suggests that current valuation discounts are not justified by fundamentals.

Over the past 25 years, in aggregate, DM small caps have delivered an average annual excess return of 1.7 ppts over large caps, primarily driven by strong performance from the end of the tech bubble in 1999 through 2011. This period was marked by robust performance in the industrials, materials, and financials sectors. After a prolonged era of mega-cap tech dominance, investor appetite could very well broaden. Small caps’ greater representation in sectors, such as industrials and materials, positions them to benefit from trends like reshoring, supply chain diversification, and industrial policy—particularly in Europe and Asia. The higher domestic revenue exposure of small caps, which previously insulated them from global trade frictions and currency volatility, remains a relevant advantage amid ongoing geopolitical uncertainty.

Taken together, the outlook for US and non-US DM small-cap equities is compelling. Wide and unjustified valuation discounts, prospects for stronger earnings growth and multiple expansion, supportive macro and policy tailwinds, and favorable sector dynamics all point to significant outperformance potential in the coming year.

Investors should overweight Latin American equities in 2026

by Capital Markets Research

EM equities have performed strongly in 2025 and are on track to outperform developed markets for the first time in five years. While gains have been broad-based, Latin America (LatAm) stands out, delivering a 53% year-to-date return and outpacing other major EM regions. We expect LatAm offers further outperformance potential, supported by deeply discounted equity and currency valuations, solid momentum, and improving macroeconomic conditions.

The broader EM equity outlook is more constructive than in recent years, driven by two key factors: a weakening US dollar and the Fed’s renewed rate-cutting cycle. Although the US economy is slowing and the labor market has softened, a recession is not our base case. Historically, non-recessionary rate-cutting cycles have provided a favorable backdrop for EM stocks. This environment supports our recommendation to overweight global ex US equities (including emerging markets) relative to the United States, with a particular preference for LatAm within emerging markets.

LatAm has been underappreciated for many years, with absolute valuations near 20-year lows. Relative to broader EM equities, LatAm now trades at a near record 51% discount, largely due to a sharp divergence from Asia, where valuations have climbed significantly. This de-rating in LatAm reflects factors such as currency depreciation, commodity price weakness, slower economic growth, and political volatility. However, improvements in these areas could set the stage for stronger performance in LatAm equities.

LatAm currencies are attractively valued, with real exchange rates versus the US dollar 11% below their 20-year median. This provides a potential tailwind as global capital seeks undervalued assets amid a weakening US dollar. Additionally, technological innovation—particularly the buildout of AI infrastructure—is likely to increase demand for raw materials, benefiting commodity exporters. As the most commodity export–oriented region within emerging markets, we believe LatAm stands to gain from this trend.

Regional policy dynamics further support economic activity. While interest rates remain elevated, inflation is moderating toward central bank targets, and leading indicators point to continued cooling. As the US Fed eases monetary policy, LatAm central banks may soon follow, which could further stimulate growth. Looking ahead, major elections in 2026—most notably Brazil’s presidential race—could bolster fiscal policy, as spending typically rises in election years.

Performance momentum also makes the region’s entry point compelling. Relative equity performance momentum has rebounded from oversold levels in late 2024, and since then, LatAm equities have outperformed broader EM equities by 11 ppts. Historically, in the six previous cycles of LatAm outperformance, the region has exceeded emerging markets by a median of 84 ppts cumulatively, with cycles typically lasting about three years. If this marks the start of a new cycle, further upside may lie ahead.

The balance of risks to the earnings outlook continues to favor LatAm. The region is relatively insulated from US trade policy, benefiting from some of the lowest effective US tariff rates, unlike EM Asia, where large trade surpluses have attracted scrutiny from the Trump administration. Additionally, LatAm companies generate a greater share of revenues from markets outside the United States compared to their Asian peers.

The tariff front-running tailwind that boosted global trade in 2025 is expected to fade, with the World Trade Organization projecting global merchandise volume growth to slow to just 0.5% in 2026. This poses a significant downside risk to Asia’s earnings outlook, where analyst expectations for EPS growth of 19% appear elevated. In contrast, the consensus for LatAm is more measured, with analysts forecasting EPS growth of 5%, compared to a 9% average annualized rate over the past decade. Increasing LatAm exposure within a broader EM allocation can help mitigate Asia’s vulnerability to policy-driven headwinds.

Risks remain, including political uncertainty, fiscal and debt pressures, limited exposure to technology and AI, and the potential for weaker remittances if US growth slows more than expected. However, shifts in some of the structural themes that have hampered LatAm equities in recent years suggest that current valuations offer a compelling margin of safety, already reflecting many of these concerns.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.

The post 2026 Outlook: Public Equity Views appeared first on Cambridge Associates.

The Fed is weighing whether to lower its policy rate from 4.25%–4.50% at its September meeting, which would mark the first cut since December. After reducing rates by 100 bps in the second half of 2024, the Fed paused to assess the impact, as robust growth, a strong labor market, and sticky inflation limited the case for further cuts. In 2025, US growth has slowed—real GDP rose 1.4% in the first half versus 2.5% in 2024—while core CPI remained elevated at 3.1% in August and higher tariffs threaten to add to inflation. In July, the Fed held rates steady, citing inflation risks. However, newly revised data revealed a much softer labor market—the three-month average pace of job growth fell to 29,000 in August, down from 209,000 when the Fed last cut rates. This shift has increased the likelihood of a rate cut this month.

Looking ahead, markets expect a swift path for policy easing, with 75 bps of total cuts by year end and another 75 bps in 2026. This contrasts sharply with the Fed’s June projections, which indicated three total cuts through 2026. While the Fed’s outlook may have shifted as inflation and employment risks have evolved, market pricing remains notably more aggressive. Based on the Taylor rule, ² the current policy rate is only modestly restrictive. For the Fed to deliver the market’s expected cuts, core inflation would likely need to fall below 2% or unemployment rise above 5%—neither outcome appears likely. There is also considerable uncertainty about how restrictive policy truly is, given the resilience of the US economy. Separately, the Fed’s updated long-term framework signals a more proactive approach to fighting inflation, reflecting lessons from the 2021–22 period when policy lagged. All of this suggests the Fed will be cautious in its approach to easing.

While we expect a gradual easing cycle, a sharper downturn in growth or a significant erosion of Fed independence could prompt more aggressive rate cuts. Although US recession risk appears low, slowing growth and rising cost pressures from tariffs or inflation could further squeeze corporate profit margins and consumer spending. The secular trend of AI has helped counterbalance cyclical headwinds, but this may not pan out as expected. Fed independence also faces its greatest challenge in decades, with the Trump administration repeatedly calling for rate cuts and openly discussing replacing Chair Jerome Powell before his term ends in May. The recent attempt to fire Fed Governor Lisa Cook over alleged mortgage fraud is unprecedented. While legal and policy barriers make it difficult for the president to remove a Fed governor or directly influence policy, heightened political pressure alone tends to result in lower rates and higher inflation over time.

Still, we expect US economic growth to remain positive and the Fed to maintain its independence in setting policy. The Fed should be able to lower rates, but likely less than markets anticipate. In this environment, front-end Treasury yields may decline, while long-end yields could stay elevated as inflation, fiscal, and policy uncertainty keep term premiums high. Narrowing short-term interest rate and growth differentials between the United States and other major economies will likely further weaken the US dollar, which has already fallen this year but remains overvalued. Markets have mostly shrugged off political attacks on the Fed, but any significant erosion of its independence—though not our expectation—would likely compound these pressures, steepening the yield curve and adding to dollar weakness.

Given these dynamics, investors should temper expectations for a rapid Fed cutting cycle. We recommend maintaining a neutral duration stance versus policy and modestly tilting toward non-US assets, such as unhedged developed markets ex US government bonds or global ex US equities, which stand to benefit from a weaker dollar.

Footnotes

1. For example, SpaceX is expected to raise less than 5% of a targeted $1.75 trillion market cap.
2. The Taylor rule is an equation that prescribes a value for the federal funds rate based on inflation and the output gap.

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