Winter Outlook

Stocks have gained further ground in the fourth quarter. Doubts about the monetisation of record AI investment led to declines in mid-October and all throughout November. Even so, US indices posted modest gains as market leadership rotated, with mega‑cap tech underperforming small‑cap companies. Japanese equities led developed‑market gains, benefiting from the yen’s depreciation, while South Korean shares also advanced following a trade deal with the US.

UK stocks were supported by an increase in commodity prices, particularly industrial metals, with banks also contributing positively. However, smaller UK companies retreated as weak consumer confidence delayed spending. Large European companies made modest gains, but German and Dutch shares underperformed significantly amid slow growth.

The US Federal Reserve delivered two successive quarter‑point cuts as inflation plateaued and the labour market showed signs of weakening. In the UK, the Bank of England held rates as inflation continued to run hotter than peers. A more balanced Budget and a pledge of future tax rises allayed gilt‑market concerns, and gilts performed well as sterling strengthened. Sterling’s strength materially detracted from returns on foreign sovereign bonds. Corporate bonds also advanced, but higher‑yielding bonds underperformed.

We previously expected growth to slip below its long-term trend while inflation stayed at moderate to high levels. As US interest rates fall and companies adapt to higher tariffs, the risk of a growth slowdown has fallen. The risk of persistently high inflation has risen as the US Federal Reserve continues to cut interest rates, amid public pressure from the White House for faster, larger cuts. We therefore expect inflation to remain elevated even as growth cools only slightly. This backdrop is more pronounced in the UK, where unemployment is rising, inflation is higher and growth is weakening.

With deficits elevated and debt burdens already high across developed markets, investors increasingly view government borrowing as unsustainable. That perception is likely to keep pressure on sovereign bonds. Corporate bonds are better positioned to outperform, particularly in emerging markets where a weakening US dollar provides an additional tailwind. We expect equities to continue to do well, led by Japan, Europe and emerging markets. In Europe, recent underperformance and earnings misses are offset by a stabilising macro backdrop and lower exposure to the now overvalued tech sector, reducing risk. By contrast, US equities face a higher risk of a pullback given lofty expectations for the impact of AI. In the UK, small- and mid-caps are likely to struggle amid weak consumer confidence and anaemic growth, while large caps are less tied to domestic conditions. After strong gains, equity drawdown risk is elevated – so maintaining broad diversification across asset classes, regions and styles is essential.