After a holiday period that saw the traditional Santa rally fail to materialise, 2026 has begun with renewed vigour across global markets. The rotation trade that defined much of 2025 appears to be reasserting itself, with emerging markets and global small caps leading the charge in early January trading.

2025 in Review: A Year of Two Narratives

Looking back at 2025 with some perspective reveals a market story quite different from what many investors might recall. While the mid-year resurgence of U.S. technology stocks—particularly the Nasdaq's strong performance from July through September—left a lasting impression of continued American exceptionalism, the full-year picture tells a different tale.

The best-performing asset classes were actually emerging markets, global small caps, and other diversified cyclical exposures offering modest yield and reasonable valuations. These areas delivered returns approaching 30%, significantly outpacing the headline U.S. indices that dominated financial media coverage.

For Australian investors, 2025 proved more challenging. The ASX delivered approximately 10% including dividends, a respectable outcome in isolation, but well behind most global peers. Much of this return came from the major banks, which rallied strongly before giving back gains later in the year, while resources proved volatile and mid-cap growth stocks faced particular headwinds. Active managers found the environment especially difficult, as momentum continued to favour expensive stocks despite fundamental concerns.

Perhaps most notably, Australian and U.S. bond yields began diverging meaningfully. With the RBA potentially on a different policy trajectory to the Federal Reserve as economists remain split between expectations for hikes, holds, or cuts, this divergence may reflect genuine structural differences between the economies rather than a temporary dislocation.

The Historical Context: What Three Strong Years Might Mean

Global equities have now delivered three consecutive years of double-digit returns, a pattern that has historically coincided with the latter stages of bull markets. Looking back over 120 years of market data, these periods of sustained strength tend to cluster together, often preceding significant corrections.

This creates a genuine dilemma for investors. Momentum can persist longer than valuation-focused investors expect, yet the further markets extend beyond fundamental value, the more severe the eventual adjustment typically proves. Markets can indeed go up even more before they don't.

Current valuations across most asset classes appear elevated, though not uniformly so. The interesting opportunities increasingly lie within markets rather than across them, certain emerging markets look more attractive than others, while within Australia, the picture varies significantly between expensive bank stocks, volatile resources, and the broader market.

Looking Ahead: Building Resilient Portfolios

With analyst forecasts for 2026 clustering in bullish territory, predictions range from flat to gains of 10-18% for the S&P 500, it's worth remembering how frequently such consensus views have been confounded. In recent years, markets have surprised to both the downside (2022) and upside (2023-2025), consistently wrong-footing the forecasting community.

Rather than making bold directional predictions, our focus is on building portfolio resilience across multiple scenarios. Key questions guiding our research include whether U.S. earnings will justify current lofty valuations, particularly with expectations for 20% year-on-year growth in technology sector profits. We're also watching the U.S. credit cycle closely, spreads remain at historic lows despite elevated recession probabilities, a potential mis-pricing worth monitoring.

We continue to examine whether global cyclical diversifiers (despite their strong 2025 performance) still offer reasonable value, while also investigating neglected pockets of quality on both the value and growth spectrum. Within Australian equities, we're working with our team to understand whether current conditions represent a stock-picker's minefield or goldmine.

The honest assessment is that the outlook remains genuinely uncertain. Markets are somewhat expensive, but the catalyst for any correction isn't obvious. In such environments, disciplined diversification and valuation awareness matter more than confident predictions.