I have returned recently from a lovely Christmas holiday in the USA. Indeed, I’m happy to report that despite America’s political turmoil and divisiveness, families can still celebrate together (with minor exceptions)!! Regarding the US financial market outlook, I was struck by the universal sense of optimism. The consensus is the bull market will widen finally beyond the Mag-7.
To be sure, this bullish view is understandable. Despite Trump 2.0’s tariffs, corporate earnings are growing and the Federal Reserve is cutting interest rates. Furthermore, AI is the rage: with everyone expecting an immediate productivity payoff. In contrast, living in London, I am struck by the European public’s level of discontent and frustation with stagnant growth and poor delivery by political leaders.
However, even in 2026’s first fortnight, events in Venezuela, Greenland, Iran, and Minnesota remind us about potential risks that could upset the bullish consensus. I’ll share some of my concerns, and why I’m somewhat less euphoric.
US Economy: Expanding on a Narrow Base?
To be sure, the US economy proved more resilient than many expected in the wake of Liberation Day’s uncertainties. Nevertheless, last year’s 2% GDP growth represents a deceleration from 2024’s 2.8% gain. Moreover, I am concerned the expansion is built on an undesirably narrow base. For instance, despite the inflationary impact of tariffs, private consumption rose 2.5%; contributing meaningfully to overall GDP growth (Chart above). However, Moody’s Mark Zandi reminds us only the nation’s wealthiest households are spending more — the rest are struggling to make ends meet (next Chart).
Likewise, the earlier Chart highlights the disportionate contribution the AI infrastucture spending boom is making to US GDP. Indeed, while business investment in equipment, software, and IP represents only 12% of national income, this segment is responsible for over 40% of 2025 GDP growth.
Nevertheless, the consensus forecasts an even stronger US economy in 2026 (2.5% growth). To be sure, I expect corporate tax cuts will fuel another year of healthy capex (including AI again). And, elevated stock and housing prices may lead to additional spending amongst affluent consumers. However, with most households struggling — combined with weak residential investment and government spending — I project GDP growth of 1.5%. Likewise, I forecast S&P 500 EPS growth of 7% compared to the bouyant consensus 17% forecast. Not surprisingly, I expect modest market returns relative to the consensus.
Trump Tariffs: Waiting for SCOTUS
I won’t speculate about the the Supreme Court’s upcoming verdict on Trump tariffs, and I assume the Adminstration has a Plan B. While most trade deals have been finalised, China, Canada, and Mexico remain outstanding. Unlike the optimistic consensus, I expect the uncertainty regarding the arbitrary nature of US trade policies will be a drag on US growth this year and beyond.
In addition, I have written frequently that tariffs will not have the impact the Administration hopes for. In particular, the levies will not reduce the US trade deficit. Indeed, the overall shortfall widened in 2025, and the bilateral gaps are larger with virtually all countries, except China (Chart above). Likewise, despite the aspiration to boost manufacturing jobs, overall employment has stagnated and factory jobs are declining (next Chart).
While I won’t speculate on the verfict, if SCOTUS repeals the tariffs, equities will beneift (lower inflation, stronger GDP), bonds would suffer (larger budget deficits), and the US dollar will rally.
Fiscal Crisis: Nothing to Worry About?
Concerns about the unsustainable world-wide rise in public sector debt has slipped from the headlines, and apparently off the list of investors’ concerns. And, while the fiscal situation has deteriorated everywhere since Covid, the IMF warns America’s position is amongst the most precarious (Chart above). To be sure, it’s difficult to predict when this will become a market theme again. And, it’s right to note America’s deficit did decline from 6.3% of GDP in FY2024 to a still bloated 5.9% last year. And, resilient growth and tariff revenues have reduced the shortfall further in FY2026 so far. Nevertheless, plans to increase military spending in Europe and USA will complicate efforts to curb red ink. Indeed, the CRFB estimates President Trump’s proposal to boost these outlays in 2027 will add another $5.8 trillion to government debt in the next decade.
Fed Independence and Inflation
Again, while not a new risk, the DOJ’s opening of a criminal investigation into Fed Chairman Powell is the latest (and most blatant) example of the White House’s attempt to bend the central bank to its will. Of course the Fed will not give in to this intimidation. However, it underscores the risk about the monetary authourity’s independence, especially as the President will select Mr. Powell’s successor soon.
As I expect inflation to remain in the 2.5-3% range for much of 2026 (before reaching its 2% target next year), the Fed will proceed cautiously. Nevertheless, as part of its dual mandate, the central bank will lower rates to 3% by the end of the year. However, the bond market is unlikely to benefit; reflecting above-target inflation, fiscal concerns, and doubts regarding Fed credibility. Instead, the yield curve will steepen towards 150bp, with 10-year yields approaching 4.5% (Chart above).
Mid-Term Elections: Watch Key Sectors
As the high cost of living is the primary concern for most of the US electorate, investors should be wary of the Trump Administration’s interventions aimed at directly capping cost for politically-sensitive sectors. The Chart above illustrates price increases for food, housing, utilities, and health care are especially high. We have already seen new initiatives to lower costs in health care and electricity. I expect more will follow, especially if polls continue to predict Democratic victory in the House of Representatives. If the Democrats do succeed, efforts to cut the budget deficit will be less likely.
US Dollar: Will Foreign Investors Lose Faith?
In an earlier blog, I outlined the case for weakness in the overvalued dollar. I expect an additional depreciation of up to 10% in the period ahead. As the USA will continue to run a large current account deficit, the nation remains reliant on foreign capital inflows. So far, as international investors’ appetite for American assets has remained healthy (note the increased equity purchases and FDI, Chart above), the dollar’s depreciation has been controlled. This could change, if foreign investors lose confidence in US trade, fiscal, monetary, and foreign policies — note critical bond purchases have been declining in recent years.
Spheres of Influences and a Neo-Monroe Doctrine?
The Trump Administration’s recent national security document appears to prioritise American interests in the Western Hemisphere; explicitly defining a “Trump Corollary” to the 19th century Monroe doctrine. In 1823, however, the US was not yet a global power, and President Monroe was warning European rivals not to encroach upon America’s vital regional interests. Of course, this is not the world we live in. The USA now has critical interests in all regions of the world. In addition, the President has also downplayed the importance of international law; indicating that his “personal morality” was the only constraint on his decision-making. President Trump’s suggestion that America is signalling a return to a “spheres of influence” worldview would have important implications for investors (not to mention the world).
Weakens the Case for Overweight Europe
We have advocated an overweight position in European equities. After a long period of economic and market underperformance, European stocks outperformed the USA in 2025, and have roughly kept pace over the past three years. The case for Europe has been based on a clearer inflation outlook, higher defense spending boosting GDP growth, and cheap valuations.
Political uncertainty emanating from the so-called “Trump corollary” may upset the case for European equities. First of all, President Trump’s aspirations in Greenland inevitably would end NATO. Fortunately, both Congress and the US military oppose taking the country by force, and I expect a NATO-led North Artic strategy will be negotiated eventually. Nonetheless, the USA is seen as an increasingly unreliable partner.
Likewise, while President Putin is no stranger to ignoring international law, any indication of an American withdrawal from Europe will make peace in Ukraine more difficult, and potentially increase Russian ambitions in the European “sphere of influence”.
With financial markets focused on the potential AI productivity windfall, Europe’s lagging efficiency performance may curb investors’ appetite for regional investments (earlier Chart). In addition, European valuations are no longer cheap, although equities still trade a large discount to the USA (Chart above). Nevertheless, while my enthusiasm may be tempered, I still favour European stocks in 2026.
China: Two-Tier Economy Poses Risks
China’s unbalanced, two-tiered economy could pose market risks. On the one hand, the domestic economy remains extremely weak. Despite efforts to cure the real estate crisis, corporate debt continues to rise. Government stimulus has failed to boost consumer spending, and public sector debt is advancing sharply (Chart above).
On the other hand, China continues to build a dominant position in key sectors of the future: EVs, AI, etc. In addition, China has offset the impact of Trump’s tariffs by boosting intra-Asian trade, as well as boosting exports to the EU, Africa, and elsewhere (Chart above). Reflecting weak domestic demand, however, imports have slumped. As a result, China’s trade surplus has soared.
Such beggar-thy-neighbour trends, supported by an undervalued Yuan, are not sustainable (Chart above). Therefore, CNY is likely to appreciate. However, if Trump escalates the biltateral trade war, China could retaliate by allowing CNY to weaken. In addition, I do not expect the “Trump Corollary” to impact China’s long-term approach to Taiwan. While I remain pessimistic about Chinese GDP growth, increased equity positions are warranted given the country’s impressive technological innovation.
Emerging Markets: Key Overweight
Like China, other Asian nations have avoided the worst impact of Trump’s tariffs by deepening regional trading links. And, while an America geo-political deprioritisation of Asia would be unwelcome throughout the region, Asian nations will respond by further deepening regional supply chains and trade links with China. In addition, strong consumer spending and business investment have offset the external drag (Chart above). Likewise, continued low inflation contributes to the case for overwight EM positions. In addition, EM markets remain cheap, especially relative to developed markets (next Chart).
Venezuela: Sentiment May Shift
Given the prospect of lower oil prices, markets have viewed the removal of Venezuelan President Maduro positively. To be sure, Venezuelan oil production has declined sharply in recent years (Chart below). However, this favourable assessment may change, as the cost of extracting Venezuelan oil is prohibitive at present. Likewise, market risks may increase if the “Trump Corollary” leads to more aggressive action against Cuba (likely), Colombia (less likely), and Mexico (not likely). In addition, sentiment towards the USA may shift unless a plan for democratic transition emerges in Venezuela. Otherwise, the incursion may come to be seen as simply an imperialist, neo-colonialist extraction of natural resources. Not a good look for the Trump strategic vision.
