Can the rally broaden?

Last month was a timely reminder that markets rarely move in a linear fashion. November may well have been a prelude to the key investor considerations and forces likely to shape markets again in 2026. Our Chief Investment Office explains further.

As we enter the final month of the year, the global easing cycle remains uncorrelated, the growth outlook uneven, and earnings potential disparate across regions. Nonetheless, we maintain a constructive view on risk assets and see scope for further gains in the year ahead.

However, this year’s winners will not necessarily be the same next year. In November, we began to witness a rotation from growth to defensive sectors. These moves came despite a strong earnings season for key technology stocks, with 2025 consensus earnings-per-share (EPS) growth expectations for the Magnificent Seven rising to more than 22%, up from 15% just six months ago. Looking ahead, expectations are for this segment to again lead in 2026, with EPS growth forecasts lifting to 22.5% versus 11% for the rest of the index.

For investors, the muted returns from tech stocks last month suggest expectations are already elevated, and doubts are beginning to linger as to whether growth targets can be met. One of the key questions heading into 2026 will be whether the market rally can broaden or concentration levels at the top of the index will continue to rise.

We believe the AI capex cycle will eventually end in tears – almost all do. But given the stated strategic sovereign importance of AI technology and fortress balance sheets of hyperscalers, it would be premature to call an end to this cycle after only 18 months. The internet build-out lasted more than a decade and given that the final stages of a bull market often deliver the largest gains, we are reticent to go short at this stage. Moreover, following the recent pullback in technology stocks, the sector has seen no meaningful multiple expansion this year – a sharp contrast to the tech bubble – making it difficult to characterise today’s market as the same.

There has been little multiple expansion in tech this year

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Nonetheless, we are closely monitoring indicators such as hyperscaler free cash flow, AI adoption rates among large firms, user growth, and productivity gains for any signs of slowing momentum.

Irrespective, 2026 will likely need to provide further evidence of real-world applications for technology stocks to retain leadership. We are assessing whether the year ahead may instead favour those companies that can demonstrate tangible use cases – and whether China can be a formidable competitor in the race for AI supremacy.

Another critical factor for a broadening of the market rally will be whether any lift in US consumption proves sustainable. Historically, household spending has been a key driver of US GDP growth – accounting for well over 60% annually. This year, however, AI-related capex has been the primary engine.

Currently, the US labour market is deteriorating and consumer confidence is at its lowest level since Liberation Day. Positively, the market is fully priced for a December rate cut, and ANZ expects the FOMC to deliver a further 50 basis points of easing in H1 next year. Add to this the stimulatory measures from the One Big Beautiful Bill (OBBB) – including the extension of the 2017 tax cut, increased deductions for state and local taxes, and the elimination of taxes on overtime and tip income – and provided the jobs market doesn’t capitulate, the consumer should be better placed to spend in early 2026.

Looking across the market, Consumer Discretionary and Consumer Staples have been among the biggest laggards in 2025, small caps trade at the steepest discount to large-cap peers since the dot-com bubble and interest expense as a percentage of total debt sits at roughly 7% for the Russell 2000, compared to 4% for the S&P 500.

All things considered, with small-cap EPS growth expected to lift in 2026, alongside potential OBBB stimulus and rate cuts, there is room for market leadership to rotate – however, we are not yet convinced it can be sustainable.

Consumer stocks have lagged

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While the consumption story has been a headwind in the US, Australia presents a different picture.

Australian GDP rose 0.4% q/q in Q3 2025 to be 2.1% higher over the year. Domestic demand surged 1.2% q/q – its highest rate in two years. Together with strong unit labor cost growth and the October inflation result, the RBA is likely to keep rates on hold for the foreseeable future.

We expect the curve to continue flattening, with long-end yields declining as markets price slower domestic growth constrained by tighter monetary policy. Conversely, the short end should remain elevated as inflation pressures persist.

From an equity perspective, the Australian index is not cheap, and earnings growth appears weak relative to peers. However, we have started to see early signs of economic acceleration in several leading indicators, including the DeepMacro Growth Indicator, Melbourne Institute Leading Index, and Citi Economic Surprise Index. We also acknowledge potential upside surprises in earnings from the Materials sector due to higher commodity prices and to a lesser extent banks where some valuations are already rich.

Domestic leading indicators have started to show some positive momentum

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As we look toward 2026, the path for markets will likely remain non-linear, shaped by uneven growth, evolving policy, and shifting sector dynamics. While technology remains central to the narrative, the potential for a broader rally – driven by stimulus, rate cuts, and improving earnings in lagging sectors – may yet surprise. For now though, we continue to favour developed markets ex-US, mega-cap US tech and emerging market equities given valuation and stimulus dynamics.

What this means for multi-asset portfolios

Over the past month, we elected to upgrade risk across multi-asset portfolios.

With recession looking less probable we took the modest increase in high yield spreads as an opportunity to close our mild underweight, taking the position to an overweight across portfolios.

Within equities, strong outperformance, particularly from China has led us to take some profits this month. Broadly speaking, emerging markets continue to offer more attractive valuations and higher earnings growth potential than developed markets and we remain overweight accordingly.

To reflect the upside momentum in domestic earnings, we have modestly reduced our Australian equity underweight this month as we increased risk across portfolios – targeting the Materials sector.

We now position overweight growth assets, while maintaining a preference for long duration as a hedge against equity risk and considering expected curve dynamics.