Market Outlook: Macro Calm, Micro Storm

The contours of the 2026 financial landscape are beginning to firm, revealing a world of structural divergence and a clear mandate for active management. Dependence on momentum from the broad equity rally likely will prove costly.

We prefer equities over bonds. Against a backdrop of emerging macroeconomic stability, the corporate profit growth story is more compelling than the search for yield. Central banks appear to be pivoting, shifting focus from pure inflation-fighting to managing a soft landing, which provides the necessary runway for company earnings to grow.

Positioning for Divergence in Asset Classes

We think the most defining feature of the new year will be increasing divergences within asset classes (Exhibit 2). This is the key reason why the old passive, beta-heavy playbook is changing.

For equities, we are cautious about healthcare. The sector faces another year of regulatory flux in the U.S., with policy changes likely to trigger higher insurance premiums and reduced coverage for a significant portion of the population. Simultaneously, the continued, bumpy shift toward "value-based" care models presents a genuine challenge to legacy business structures. Security selection is key.

AI bolsters the secular case for real assets, especially infrastructure. These assets are a direct beneficiary of long-term investment trends in technology (data centers) and energy transition (renewables, transmission grids). Infrastructure offers resilience and a necessary hedge against inflation that few other asset classes can provide.

In fixed income, credit fundamentals are set to weaken, particularly for highly levered, small-cap U.S. issuers whose thin margins are most exposed to the protracted struggle of the lower-end U.S. consumer.

Furthermore, relying solely on Treasurys for portfolio diversification is a relic of the past decade. A protracted downward pressure on the U.S. dollar, driven by the convergence of global central bank policy and the sheer weight of U.S. deficits and debt, makes the case for broadening the fixed income portfolio. We think global government bonds offer superior diversification benefits and a currency tailwind.

Performance Through Selection

This environment signals that security selection must become a core part of the allocator’s toolkit, demanding a higher allocation to truly active strategies. We believe investors’ ability to distinguish between winners and losers in a fragmented market will generate alpha, not simply mitigate drawdown.

Inflation in Focus: Navigating Tail Risks and Opportunities

While we expect inflation to remain contained, it continues to run at an above-average rate of about 3%, and there are heightened tail scenarios of inflation running hotter than what is priced into the market.

The Fed’s Balancing Act May Set Up Inflation

In late 2025, the Fed shifted to cutting rates, favoring support of the weakening labor market over their other objective of fighting inflation — even though it is still above their 2% target. We believe this bias toward firing up the economy over inflation-fighting creates more risk that inflation stays above target.

Further, deglobalization, reflected in recent tariffs and tighter immigration policies, can put pressure on prices through goods and wages. As of yet, we have seen muted impact, but this can creep higher over time as these pressures pass through to the final consumer in higher goods and services prices.  In addition, there are multiple geopolitical hot spots where flare ups can put pressure on global supply chains.

One offsetting factor for inflation is the AI expansion which can lead to productivity gains and offset labor pressures. Yet, required infrastructure, including increased energy, water and other materials, needed to fuel AI expansion can put pressure on supply chains.

Unusual Environments Create Opportunity

Historically, traditional bonds have been the best asset class for managing the risk of deflation or declining growth. Going forward, with heightened tail risk to inflation, one would expect the market to put a premium on inflation-protected securities like Treasury inflation-protection securities (TIPS), since they return the greater of inflation-adjusted principal or par value at maturity.

Yet, this is not the case. Exhibit 3 shows the split of Treasury yields between real rates and the breakeven rate, the inflation rate where investors are indifferent between owning TIPS or similar maturity Treasurys.  The five-year and 10-year breakeven is at 2.45% and 2.37%, respectively. If inflation continues at the 3% level or higher, TIPS investors are better off.

As Exhibit 3 shows, TIPS as of September 30 were not pricing much of a premium given current inflation is running higher than the breakeven rate, creating a potential opportunity for fixed income investors looking for long-term inflation protection.

Private Credit: Resilience, Reinvention and Room to Run

Private credit enters 2026 with momentum, even as macroeconomic challenges and tighter spreads persist. Forecasts suggest the asset class could surpass $5 trillion by 2029, underscoring its durability and appeal.¹ While direct lending remains dominant, asset managers are increasingly diversifying into niche strategies like asset-based finance, infrastructure debt and special situations.

Shifting Borrower Behavior
Regulatory constraints on traditional banks and a slower merger-and-acquisition environment are driving borrowers toward private credit for its speed, flexibility and customization. At the same time, retail and insurance capital pools are emerging as significant funding sources, expanding the investor base and deepening market liquidity.

Structural Innovation
Fund structures are evolving to meet investor needs. Evergreen vehicles and continuation funds are gaining traction, offering solutions to liquidity constraints and demand for flexibility. The rise of evergreen structures is particularly notable, with growth expected to continue into 2026.

Performance Outlook
Senior direct lending strategies are poised to deliver resilient returns, supported by elevated yields and strong borrower fundamentals. The illiquidity premium continues to drive outperformance versus public markets and liquid alternatives. Since 2000, private credit funds have outperformed their public market equivalents by an average of 3.2% annually, a trend expected to persist.²

Dry Powder Dynamics
Private equity buyout dry powder still far exceeds that of direct lending (Exhibit 4), suggesting ample runway for growth in private credit. This imbalance highlights the opportunity for direct lenders to continue to grow market share and drive higher origination volume.

High Yield: Stability, Selectivity and Strategic Shifts

As we approach 2026, the macro backdrop for credit markets is broadly constructive. Expectations for Federal Reserve easing, potential fiscal stimulus, and a stable economic environment are setting the stage for continued resilience across fixed income. Credit losses are projected to remain below long-term averages, supported by steady fundamentals and disciplined corporate behavior.

Fixed Income Positioning in a Lower Rate Environment

Within the broader credit landscape, fixed-rate instruments are well positioned to benefit from a declining rate environment. This dynamic has already begun to play out, with fixed-rate credit like high yield outperforming floating-rate segments such as leveraged loans in 2025.³ As policy rates move lower, duration exposure may become a more meaningful driver of relative performance.

Defaults and Recoveries: A Constructive Year

Default rates are expected to remain below historical norms (Exhibit 5), aided by supportive policy and economic conditions. Recovery rates have been elevated, driven by liability management exercises (LMEs) that offer more favorable outcomes than traditional bankruptcies. These trends suggest that expected credit loss over the next year will be relatively modest.

Fundamentals and the Role of Active Management

Corporate fundamentals remain solid, with earnings growth expected to support stable leverage and improving interest coverage. Issuers with floating-rate debt stand to benefit from declining base rates, while refinancing activity may further enhance balance sheet flexibility. However, dispersion within credit quality — particularly among lower-rated issuers — underscores the importance of security selection and active management in navigating potential risks.

Thematic Momentum: AI Infrastructure and Credit Demand

One emerging theme is the role of credit markets in funding AI infrastructure. Over the past year, seasoned issuers have tapped demand tied to power, data centers and related technologies. This trend is expected to accelerate in 2026, with new entrants raising capital to support growth initiatives in digital infrastructure. Credit markets are increasingly serving as a strategic financing channel for innovation-driven sectors.

Alternatives: The Battle for Liquidity

The landscape for multi-asset portfolios is undergoing a profound transformation. Traditional diversification benefits from stocks and bonds have diminished, as evidenced by rising correlations over the past decade. Traditional private equity buyout, growth and venture capital funds have also lagged public markets since 2022 . This shift is prompting investors to look beyond conventional assets and evolve their approach to portfolio construction with alternatives.

Liquidity Management: Central to Portfolio Design

Liquidity isn’t a free lunch — in 2026, investors will need to manage and integrate liquidity costs with more precision. Despite optimism in mid-2025 about a rebounding initial public offering (IPO) market, exit activity was limited, with only a few notable tech names making headlines. The aging issue in private equity persists, with over 12,000 U.S. companies in inventory and a projected seven-year exit backlog.

Investors are responding by adopting diversified liquidity solutions through use of limited-partner-led secondaries as a strategic tool and private credit to generate cash flows for funding commitments or participation in new vintages. The distinction between liquid and illiquid assets is shifting, with growth in secondaries, improved data transparency and new fund structures driving a more nuanced approach to liquidity across the public-private spectrum.

Redefining Alpha in Alternatives

With global alternatives assets projected to reach $32 trillion by 2030,⁴ dispersion in manager skill and strategy complexity will continue to drive varied outcomes for investors. In private equity, operational excellence — especially in mid- and lower-middle market strategies — will be key to generating alpha, as higher neutral interest rates shift the focus to profit growth. Private credit is evolving, with tight spreads making direct lending less attractive and return potential shifting to more complex strategies such as asset-backed finance, distressed credit, and real estate debt. Within private infrastructure, moderating inflation and geopolitical uncertainty will challenge core strategies, driving investors to value-add and mid-market opportunities in digital and energy infrastructure.

Sourcing Differentiated and Less Crowded Opportunities

Alternatives offer access to exposures tied to macroeconomic and fiscal policy dynamics, as well as structural shifts driven by AI and deglobalization. While these shifts can drive industry transformations and future enterprise value creation, investors must be discerning with a focus on entry valuations and pace of AI adoption (Exhibit 6). In 2026, we believe investors will seek opportunities across the value chain beyond traditional private equity or venture capital to identify and unlock undervalued assets and enhance portfolio diversification.

U.S. Equities: Beyond the AI Boom

U.S. equity markets head into 2026 after three years of robust gains, fueled by AI-driven enthusiasm, resilient corporate earnings and expanding valuation multiples. While these tailwinds have pushed indexes to new highs, they’ve also been accompanied by heightened geopolitical risk and episodic volatility.

While technology spending remains a secular growth driver, valuation discipline is increasingly critical because mega-cap growth multiples have pulled away from the pack. Even AI is not immune to cyclical pressures, and with below-trend economic growth expected, investors may benefit from a more selective approach. Rising volatility and heightened sensitivity to AI sentiment may favor companies with strong profitability, prudent capital management, and reasonable valuations — hallmarks of the quality and value equity factors. Defensive sectors may also offer resilience in what could be another choppy year.

Navigating Narrow Leadership

Recent market performance leadership continues to be concentrated in a few mega-cap and AI-linked names. It is difficult to say how sustainable this is, but with concentration in the S&P 500 at record levels, investors may seek to prioritize diversification of exposures. Expectations for continued Fed easing could be a tailwind for markets overall — including tech leaders — should the current “soft landing” mixture of modest inflation and positive but below trend economic growth persist into 2026. However, should leadership broaden in line with historical norms, other areas of the market may benefit.

In this context, a pivot toward companies with durable fundamentals and attractive valuations appears timely. Historically, the quality and value (quality as defined by profitability and capital discipline, and value as defined by relatively low multiples) have outperformed in economic slowdowns and lower-return environments (Exhibit 7). Today, with value trading at favorable levels relative to its historical average relative to growth, these segments offer a potential anchor for portfolios amid shifting market dynamics.

Defensive Positioning for Uncertain Times

Low volatility stocks also deserve renewed attention. In 2025, markets experienced sharp drawdowns tied to events like DeepSeek and Liberation Day, during which low-volatility equities provided meaningful downside protection. With uncertainty likely to persist — driven by both known and unforeseen risks — stocks with lower risk profiles and higher quality characteristics may continue to serve as portfolio shock absorbers, while still participating in upside.

In an environment marked by elevated valuations, episodic volatility, and speculative narratives, a renewed focus on valuation sensitivity and portfolio defensiveness is warranted. For 2026, we believe quality, value, and low-volatility exposures can help advisors position client portfolios for resilience and long-term success.

¹ PitchBook, as of May 2025

² eVestment and Cambridge Associates as of March 31, 2025

³ Source: Bloomberg, from December 31, 2024 to November 10, 2025.

⁴ Preqin Private Markets in 2030 Report, October 2025