Enough reasons to look up

• High valuations and earnings expectations
• How cautious is the Fed?
• Bonds: preference for quality

In the current market environment, it’s understandable that some investors are questioning whether stock prices and valuations have climbed excessively. Over the past three months, US and Japanese equity markets have reached new record highs, while emerging market indices hit their highest levels of this year. European equities mainly moved sideways, after reaching new record levels earlier in 2025. In euro terms, Europe remains the outperformer among equity regions this year so far. Hence, despite regional differences, overall sentiment in equity markets is positive.

Equity valuations are also high. In the US, valuations are significantly above their historical long-term average – and even near their peak. In Europe, Japan, and emerging markets, valuations are slightly above their historical averages.

With equity indices and valuations at high levels, the question arises whether there is now reason for ‘fear of heights.’ Admittedly, we cannot rule out that equity markets may consolidate in the short term. But we see sufficient upward potential for equities in the medium term. With that in mind, we decided in early September to increase our equity weighting from neutral to modestly overweight.

Indeed, equity valuations have risen, most notably in the US tech sector. However, the market expects corporate earnings growth to reach double-digit percentages next year. To some extent, rising equity valuations are therefore justified. In our view, current valuations are not a reason to become less positive about equities.

At the same time, there is no reason to be overly enthusiastic. Risks remain. For instance, we believe markets may be too optimistic about the Federal Reserve’s (Fed) expected interest rate policy. Inflation in the US still runs above the Fed’s target level, largely due to the implementation of import tariffs. These same tariffs are slowing down the US economy. The Fed therefore cut its policy rate by 25 basis points last week. In our base-case scenario, we anticipate that the Fed will refrain from making additional rate cuts this year but will reduce rates by 25 basis points per quarter in 2026. These moderate rate cuts are intended to support the economy, while keeping inflation under control.

Overall, we foresee a less aggressive rate cut cycle than what financial markets currently expect. Lower interest rates are generally favourable for equities. However, if the Fed next year chooses to lower rates less than investors are pricing in, this could lead to disappointed market reactions.

That said, the economic picture remains positive. Regarding import tariffs, the most pessimistic macro scenarios have been averted, and uncertainty for businesses and consumers has decreased. We expect lower growth for the remainder of the year, followed by a pick-up in growth in 2026. The decrease in uncertainty and the economy’s resilience are reassuring – making the outlook favourable for equities.

While the Fed cut its policy rate last week and is likely to continue doing so next year, the European Central Bank (ECB) recently completed a rate cut cycle. Therefore, in Europe, we do not expect lower bond yields anytime soon. Meanwhile, European governments are planning large-scale investments in defence. These expenditures will be financed with new debt, meaning long-term bond yields are likely to rise. For this reason, we avoid the long end of the yield curve (maturities of 10 years and beyond).

We maintain our modest overweight position in bonds. We believe that high-quality bonds will deliver better returns than interest on savings accounts. We are less enthusiastic about the riskier high-yield segment. Risk spreads on high-yield bonds are currently low and do not sufficiently compensate investors for the extra risk they take with these bonds.

Recent increases in equity prices and valuations may easily trigger a sense of ‘fear of heights.’ When scared of heights, looking down is not always the best idea. Instead, we focus on the favourable economic picture, solid earnings expectations and positive sentiment in equity markets – plenty of reasons for investors to keep looking up for now.