Q4 2026 Asset Allocation outlook: Navigating crosscurrents

The following is an excerpt from our Q4 2026 Asset Allocation outlook.

A crowded menagerie features heavily in most descriptions of financial market conditions. Bulls battle bears, hawks spar with doves, and investors hunt for unicorns. However, when thinking about the current environment and outlook, a
different animal springs to mind. Fans of Doctor Doolittle will know that the pushmi-pullyu is the “only twoheaded beast in the world”: one that resembles a llama but with a head at either end of its body. Like the pushmi-pullyu, markets have been pulled in different directions since the start of the year by the opposing influences of artificial intelligence (AI) and the commodity market consequences of the conflict in the Middle East.

A two-headed beast

The “pushmi” (AI) part of the equation has driven extraordinary earnings growth for the largest US corporates. In Q2, GAAP earnings for the Magnificent Seven grew by around 120% year-on-year [1]. Those numbers are flattered by the revaluation of on-balance sheet investments, but operating margins were also incredibly strong. In 2026, the rising tide of corporate earnings has spread across sectors and geographies. The market is taking the prospect of a secular increase in the capital share of income seriously as AI augments and displaces labour.

The “pullyu” (oil) comes from festering tensions in the Middle East. The flow of oil and gas through the Strait of Hormuz remains severely impaired six months after the conflict erupted in the Spring. The rise in oil prices has been eclipsed by an even stronger surge in the price of distillates and liquefied natural gas (LNG), triggering soaring bond yields. China is the only major country which has been immune from that repricing with yields pinned down by depressed domestic demand. Fundamentally, it is hard to see the hiatus in oil and gas supplies extending much further without end-user demand destruction becoming necessary to rebalance the market: inventory drawdown can only run so far. 

Positioning for competing forces

Our response to those offsetting forces has been to dial up our equity exposure in the aftermath of the conflict flareup while staying cautious on credit, particularly in investment grade-rated markets. Having lagged the rest of the world in the first two quarters of the year, we think tech-heavy US equities can reassert leadership. The “pushmi” strength is such that equity markets have derated relative to earnings expectations despite prices rising. We believe this could be an ideal combination for investors worried about the longevity of the market rebound.

For bonds, the “pullyu” is the third major supply shock in recent years after COVID and the Russian invasion of Ukraine. Central bankers are trying hard to maintain credibility without raising rates to recession-inducing levels. We have sought shelter in Japan where underlying inflation continues to look muted and in the long-end of the curve where yields are less sensitive to changing policy perceptions. After the travails of the last few years in the bond market, it is worth remembering that investors have enjoyed annualised real returns above 2% on fixed-income assets over the last 100 years [2]. With real yields back well above zero, we believe the prospect of positive real returns on the bond market is back.

Read our Q4 2026 Asset Allocation outlook

[1] https://insight.factset.com/mag-7-companies-reported-earnings-growth-above-100-boosted-by-investment-gains

[2] “Stocks for the Long Run? Sometimes yes, sometimes no.” McQuarrie (2023)