Q1 2026
Equity markets around the world had to navigate a raft of different headlines in 2025, but ultimately concluded the year with healthy returns across the board. The MSCI World Index recorded a price return of 17% in local currency terms, rebounding strongly from a sharp drawdown during April’s period of trade-related turbulence. Developed markets outside of the US outperformed their US counterparts on an annual basis for only the fourth time in the last two decades, with currency moves adding to regional dispersion. Higher quality companies lagged their lower quality counterparts, with investors willing to overlook company fundamentals to instead focus on positioning for a cyclical rebound in the global economy.
We believe that regional diversification should enhance the chances of success for equity investors in 2026. Such an approach not only helps to manage the high degree of tech concentration in US benchmarks, but should also enable portfolios to benefit from the broadening of earnings growth across regions and sectors that we see ahead. At the same time, following a year where company fundamentals were largely overlooked, a shift up the quality spectrum is worthy of consideration for investors looking to boost portfolio resilience.
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Valuations are elevated across the board
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High valuations offer little signal about near-term returns
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Earnings growth looks set to broaden by region and sector
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Germany’s fiscal pivot is a key part of Europe’s earnings resurgence
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Higher quality stocks rarely underperform for extended periods
Following a strong run for risk assets, it’s undeniable that valuations are elevated relative to history in almost all major equity markets. In the US, the S&P 500 Index began 2026 trading on a multiple of 22x 12-month forward earnings. While the S&P 500 has only traded at higher valuations for 7% of the time since 2000, it’s important to recognise the contribution made by just a handful of stocks.
The top 10 stocks in the index started the year on a valuation of 28.6x, which in large part reflects ongoing investor enthusiasm about the prospects for artificial intelligence. Elsewhere around the world, valuations are lower in absolute terms but are still relatively high vs. history. At a sector level, regional dispersion remains significant, with almost all European sectors trading at a larger-than-average discount to their US counterparts.
12-month forward P/E ratios
x, multiple, percentiles and median since 2000
Valuations have a close relationship with forward-looking returns over long periods, but tell you little about where equity markets might move in the next 12 months. From current valuation levels of 22x for the S&P 500, we can find historical examples of 12-month periods that have seen price declines of more than 20%, as well as rallies to the tune of close to 40%. The reason for this dispersion is that changes in valuation are only one component of equity returns. Strong earnings growth can help companies to “grow into” high valuation levels, while still seeing share price appreciation. Lofty valuations are therefore not prohibitive of strong gains in the near term, but they do leave little room for disappointment if earnings are weaker than expected.
S&P 500 forward P/E ratios and subsequent one-year returns
%, annualised total return*
Given the importance of earnings delivery, it is good to see that analysts are broadly expecting a strong year of profit growth in 2026. At a developed market level, analysts are forecasting impressive earnings growth of 14%, which if delivered would mark the strongest year of earnings growth since 2021. A key difference between this year and last, however, is the regional make up of these earnings. European companies are expected to return to the party, delivering double-digit profit growth after seeing earnings contract in 2025. The outlook is similarly positive further east, with Japanese earnings forecasts having witnessed a raft of upgrades following the election of Sanae Takaichi last October. At a sector level, earnings growth is also expected to broaden after tech companies did a lot of the heavy lifting in 2025.
Consensus estimates for global earnings-per-share growth
% change year on year
Drilling a level deeper into Europe’s earnings outlook, currency moves played a big role in last year’s disappointment. In a year where domestic-focused sectors actually saw profit expectations upgraded, export-oriented sectors were hit hard by the strength of the euro vs. the US dollar. While we do see room for further euro appreciation in 2026, valuations have already reset materially. At the same time, we expect to see German fiscal stimulus finally feeding through into stronger economic activity, at a time where consensus expectations remain very muted about Europe’s growth prospects. The reluctance of European governments to spend in the last decade explains a lot of the region’s underperformance relative to the US, in our view. The change in Germany’s approach must not be underestimated.
Government investment
%, annualised change over the period
Academic research has shown that higher quality companies typically outperform their lower quality counterparts over long periods. “Quality” can mean different things to different investors, but typically references metrics such as the stability of earnings growth and the strength of corporate balance sheets. Given that these characteristics can help to reduce share price volatility, it’s intuitive that these companies are generally popular with stock pickers. History shows, however, that higher quality companies will not always outperform, and last year was one such example. In fact, between August 2024 and August 2025, higher quality companies in developed markets suffered their worst 12-month period of relative performance in more than 20 years. Crucially, such drawdowns tend to be short lived, as the chart shows. We would therefore caution against ignoring company fundamentals in an attempt to chase near-term performance.
MSCI World Quality relative performance
%, rolling one-year total return vs. MSCI World
