Investment Directions

Key market views

1. We lean into AI, growth, and large cap exposures, but see value as an important diversifier. Earnings in the U.S. have been steadily revised higher, even as volatility spiked and prices slid.
2. Outside the U.S., we prefer emerging over developed market equities, given the centrality of many EM countries in the ongoing AI buildout. Global themes such as energy security and infrastructure are likely to remain in focus long after conflict ends.
3. In fixed income, we prioritize income and see opportunities in securitized assets over corporate credit.
4. We favor a diversified basket of diversifiers, such as alternative asset classes and liquid alternative strategies. Traditional diversifiers such as duration and gold sold off alongside equities in March, a reminder that ballast is not one-size-fits-all.

The spring edition of our Investment Directions takes on a new look. As the weather heats up, our “summer body” of work embraces a slimmed down word count, Q&A format, and visual-first approach – better for consuming on the go, or preferably, outdoors.

That’s not to say the world is less complicated because the weather is better. The start of this year has seen the largest oil supply disruption in history. Prior to the conflict in the Middle East, the market was fretting about the death of software (the “DiSaaSter”), and other ways AI could disrupt existing business lines or generally fail to live up to hype.

While there are doubtless risks on the horizon, we also see opportunities: in the resilience of the U.S. economy, the continued strength in corporate earnings, and the relentless growth of AI and near-endless demand for compute. We retain a constructive outlook for risk assets, while building a diversified basket of diversifiers to gird portfolios against a growing array of potential shocks.

Latest in Markets: Inflation rising, Fed likely holds near-term

1. What does the conflict in the Middle East mean for the U.S. economy?

The Middle East conflict is pushing oil prices higher, but the implications for the U.S. economy - and markets - are more nuanced. The U.S. is less exposed than many peers given its role as a net energy exporter, which has helped cushion the growth impact relative to more import-dependent economies. Higher energy prices will still weigh on consumers, particularly via gasoline, but we expect that drag to be partially offset by fiscal support, including tax refunds.

Importantly, U.S. earnings have not been especially sensitive to oil unless disruptions persist. Historically, even large oil moves have tended to slow earnings growth rather than reverse it: since 1970, S&P 500 earnings have generally remained positive following oil increases of up to ~70% year-over-year, with negative outcomes concentrated in more extreme shocks - typically when oil spikes coincide with broader downturns.¹

Consensus forecasts for GDP continue to average 2%, though we see some evidence of recent slowing.² Perhaps more importantly, growth has become more reliant on a narrow set of drivers associated with AI and investment spending, which could make it more fragile. We think that backdrop supports staying invested in equities, despite headlines around inflation and growth shocks, while being more deliberate about diversification as volatility remains elevated.

At the same time, energy infrastructure disruption may cause energy prices to remain higher than levels seen at the start of the year. Higher energy prices may reinforce longer-term themes around energy security and supply resilience, which could drive increased investment in defense and infrastructure even after the conflict fades. Policymakers are likely to prioritize rebuilding and expanding strategic reserves and reducing reliance on vulnerable supply routes - potentially putting a higher floor under oil prices from here.

Figure 1: Market Performance & Energy Imports via the Strait of Hormuz

2. What is the outlook for inflation and the Fed?

Inflation is moderating, but the path remains uneven. Headline inflation has moved higher given energy price shocks while core inflation remains sticky around the 2.6% level – above the Fed’s target.³ While near-term pressures remain elevated, reflecting supply-side dynamics and geopolitical uncertainty, they are not driving a broad-based reacceleration in market-based measures of inflation. Indeed, there are some signs of inflation moderation: as recent CPI data show, near-term disinflation is being supported by tariff runoff in certain goods categories and continued shelter deceleration.

For the Fed, this creates a mild stagflationary trade-off. Historically, similar shocks have led to an initial focus on inflation before growth concerns dominate. However, this shock alone is unlikely to warrant further tightening. As stated at the March FOMC meeting, Federal Reserve Chair Jerome Powell believes interest rate policy is already restrictive, with the funds rate estimated at 50–75 basis points above neutral and financial conditions tighter by ~80 bps.⁴

We believe this leaves the Fed on pause and data-dependent for now, but likely to shift toward gradual rate cuts later if inflation continues to move toward target and growth moderates. With headline inflation expected to stay elevated in the near term, and the next move from the Fed likely a cut, we believe investors should focus on adding real rate protection to their portfolio via inflation-protected securities.

Figure 2: Inflation forecasts steady, but above target

3. How is the growth of AI affecting the labor market?

AI is rapidly advancing as agents undertake increasingly complex multi-step tasks, but data show that it’s mostly too soon to know AI’s impact on employment. Over the past 12 months job growth has averaged 25,000, a sharp deceleration from the previous 12 months.⁵ Still, labor markets remain in a delicate equilibrium, with unemployment holding steady around 4.3%.⁶ Deeper disruptions are happening below the surface that will determine the health of the overall economy.

• Job gains are highly concentrated in a small number of sectors. Over the past three years, payroll growth has come disproportionately from education and health care: about 2.7 million jobs in the last 3 years, which represents over 80% of jobs added during that period.
• Sectors that employ a large share of white-collar and tech-adjacent workers have seen slower growth. Growth in professional and business services and information jobs which may be especially vulnerable to AI disruption and have been weak, as shown in Figure 3.
• We believe job numbers mask other changes happening: sector-specific displacement, declining job mobility, and an expanding mismatch between where workers are and where demand is heading. The equilibrium is fragile, and further macro shocks could tip it.
• Immigration policy and demographic shifts are tightening labor supply. Census estimates show net international migration peaked at 2.7 million in 2024, fell to 1.3 million in 2025, and is projected to slow to roughly 321,000 in 2026.⁷ The Fed argues that, together with aging-related declines in participation, this combination could push labor-force growth close to zero this year and drive breakeven payroll growth toward zero.⁸

The labor market is still creating jobs in aggregate, but not in the same places or for the same types of workers. Therefore, AI-related pressures can potentially coexist with a stable unemployment rate, even as labor-market conditions become more uneven across industries, skills, and worker cohorts. This points to a labor market that is more fragile than the headline unemployment rate suggests, with enough slack in many segments to restrain inflationary wage pressure. For the Fed, that supports a two-sided focus on its mandate and raises the bar for rate hikes.

Figure 3: Jobs added and lost in past 3 years

4. How could the 2026 midterm elections affect markets?

Historically, midterm election years have been associated with more subdued market returns. But as the election nears, history has shown a tendency to rally.

Since 1990, the average S&P 500 return in non-midterm years was 12.3% vs. only 3% in midterm years. But that masks large dispersions at the sector level: Healthcare (10.7% avg) and Energy (8.9% avg) have historically held up better, while Industrials (0.6% avg) and Financials (-0.6% avg) have tended to drag the market down in midterm years.⁹

In the last 56 years, we have seen the market start to rally on average around a month (22 trading days) before a midterm election, as polling data provides clearer expectations of results. Then, as event risk passes following the election, equities have historically experienced tailwinds with an average return of 14.1% in the six months that follow.¹⁰

The outcome of the election also has affected performance. We come into the 2026 midterms with a trifecta – where one political party controls the presidency and both houses of Congress. This situation has happened just 6 times since 1970. In only one scenario, in 1978, was the incumbent government able to maintain its control of all three branches. This difficulty in keeping control matters, because the average 6-month forward return after midterms when the incumbent party loses control is materially lower (+10.4%) than in other scenarios (+16.1%). Still, we believe other durable themes such as AI will matter more for markets than politics – even in an election year. 

Figure 4: S&P 500 total return performance, pre & post midterm years since 1970

U.S. Equities: Cheaper valuations, AI & geopolitics now core themes

5. What’s happening with equity valuations and earnings growth – and where are opportunities this year?

Falling stock prices and improving earnings fundamentals have led to a reset in valuations for U.S. equities. While broad market valuations declined to multi-year lows in March, cheapening was especially pronounced in technology names exposed to the AI theme. And while prices have grown more attractive, the earnings outlook has improved. Information Technology (IT) companies in the S&P 500 are now expected to boost earnings by 38% year-over-year in 2026 vs. expectations of 24% at the start of the year. The IT sector alone is expected to account for 63% of the S&P 500’s 2026 earnings growth.¹¹

Technology continues to dominate fundamentals, but it isn’t the only sector lifting U.S. profits. Energy, materials, and utilities have all seen positive analyst revisions this year and are all now forecasted to deliver double-digit earnings growth.¹²

The resilient fundamental backdrop, strength in earnings, continued AI momentum, and attractive valuations lead to our preference for U.S. equities over other developed markets.

Figure 5: S&P 500 Index valuations fall while earnings improve in 2026

6. Should investors favor growth or value, large or small caps?

Coming into 2026 we had a preference for value, citing a cyclical upswing in growth, fiscal stimulus embedded in the One Big Beautiful Bill Act, and looming Fed cuts leading to a steeper yield curve. Now, conflict in the Middle East has modestly shifted our preference: economic growth remains resilient, but higher energy costs and delayed Fed easing may weigh on the consumer.¹³ With technology earnings growth driven by ongoing AI adoption, we see that sector as relatively less sensitive to consumer spending, and see large cap companies as better suited to weather higher interest rates. Value and momentum remain valuable diversifiers.

• We adopt a balanced stance between growth and value. Earnings growth has remained strongest in growth and technology, reducing concerns about valuations. The spread in relative valuations between growth and value has compressed significantly (Figure 6). Earnings growth is more concentrated than forecasted at the start of the year, while value, particularly energy-linked exposures, has become more expensive with the rise in crude oil prices. Still, we believe value exposures can provide valuable diversification benefits to growth heavy portfolios – a key reason for our balanced approach.
• Small cap equities face ongoing headwinds. Smaller companies have tended to outperform in early-cycle recoveries, when interest rates are below trend and growth is above trend.¹⁴ But current sentiment, financing conditions, and macro uncertainty remain less supportive, keeping our confidence in small caps subdued. While we have a conviction in large caps more broadly, small caps have the potential participate in periodic low-quality, high-risk asset rallies.
• We remain nimble. We keep our preference for solutions that can actively rotate between style and factor exposures. 

Figure 6: The valuation differential between large cap growth and large cap value has narrowed

7. What equity themes are in focus right now? 

Themes such as AI and geopolitical fragmentation have become core macro forces shaping growth, inflation, and market leadership. AI has evolved beyond narrow mega-cap technology leadership into a broad, cross-sector opportunity set, spanning power generation, data center buildout, and hardware supply chains. Meanwhile, recent spikes in geopolitical tensions are bringing energy security and independence into focus. Both are creating opportunities across the energy value chain—from traditional oil production to grid modernization—supported by increased investment from governments and the private sectors globally to meet rising energy demand. Investments in power grids alone exceeded $470 billion in 2025 and are projected to rise by 16% annually to meet surging renewable energy demands.¹⁵

We remain constructive on structural thematic growth, but rapid shifts in winners and losers require more deliberate allocation decisions. A perennial preference for value exposures leaves the average moderate advisor portfolio with just 28% exposure to companies with material AI exposure in their equity sleeve vs. 45% in the S&P 500 index.¹⁶ We believe in a more intentional approach to target the full value chain of a theme or complement broad exposures with a focused thematic sub-layer. For example, investors could seek exposures to all parts of the AI stack in an active strategy, or focus on just power infrastructure, investing in the “picks and shovels” of AI while addressing energy supply bottlenecks.

Figure 7: Annual energy investment by countries and regions in $bn

Fixed Income: Short-term in the near-term

8. Is private credit a systemic risk to the market?

We believe private credit is not currently exhibiting characteristics of systemic risk. Systemic risk would require widespread defaults, excessive leverage, and destabilizing liquidity spirals. The current environment is one of normalization and dispersion.

Private credit defaults are rising modestly, but from unusually low levels. Current default rates of about 2–3% remain below long-term averages (about 3.5%), and we believe even a move towards 7–8% would represent normalization rather than distress.¹⁷ Defaults remain idiosyncratic, with stress concentrated in pockets. A systemic event would likely require rising correlations and synchronized weakness – conditions not observed today.

Leverage and loss severity remain contained. Private credit is typically underwritten with conservative structures (about 40–45% loan-to-value), supported by strong documentation, concentrated lender groups, and covenant protections.¹⁸ This structural control is intended to help reduce the risk of disorderly loss transmission.

Liquidity concerns have been misrepresented in the media as “gating.” Redemption limits in private credit vehicles are a common design feature set forth in fund documents intended to ensure orderly liquidity. They exist to prevent forced-selling dynamics typical of systemic crises.

Software exposure represents dispersion within private credit portfolios, not a systemic risk to the asset class. Software platforms with embedded customer relationships have remained resilient, while seat-based models face pressure. While private credit has meaningful software exposure, equity selloffs do not automatically translate into fundamental credit risk for senior secured lenders. Equity returns are driven by long-term growth and terminal value assumptions, while private credit returns depend on near- to medium-term cash flow generation.

Figure 8: Trailing 12-month income return and realized gains (losses) for the Cliffwater Direct Lending Index

9. Where are attractive opportunities in fixed income?

We favor the front end and belly of the yield curve, where we feel yields remain attractive after moving higher at the start of the conflict in the Middle East. Front-end yields are compelling, with 1-year tenors currently yielding ~3.7%, up nearly 22bps since early March.¹⁹ Inflows into exchange-traded products reflect this preference, with short- and ultra-short-term bond ETFs gathering $53 billion year-to-date, representing 36% of all fixed income ETF inflows, compared to $18.6 billion into medium- and long-term bonds.²⁰

The recent rise in short rates has been driven primarily by tighter interest rate policy expectations from elevated energy prices. This has also pushed real yields higher, making TIPS increasingly attractive to target elevated real yields.

We remain cautious on longer-duration rates given persistent inflation, deficit concerns, and structural supply pressures, which may keep upward pressure on global long-end yields. Ongoing U.S. fiscal imbalances continue to support rising term premium for long-term bonds, while potential normalization in Japanese monetary policy may further contribute to higher global long-term rates.

Wider spreads have created more compelling entry points in high-quality fixed income, particularly in sectors tied to the real economy and less exposed to technological disruption. We see increasing value in “HALO” (Heavy Assets, Low Obsolescence) assets, which favor tangible assets that may be less subject to AI disruption. Commercial mortgage-backed securities (CMBS), residential mortgage-backed securities (RMBS), and other asset-backed securities (ABS) exemplify this theme, with CMBS yields around ~4.7% and ABS yielding ~4.5%, providing a practical way to incorporate evolving AI risks into fixed income allocation.²¹

For investors considering international bonds, we prefer EM hard currency debt given the current regime of elevated energy prices and tighter global financial conditions. Wider spreads and improved all-in yields may offer more attractive carry, while limiting exposure to FX volatility and inflation pass-through that continue to weigh on local markets.

Figure 9: Yields have risen YTD, and are attractive compared to core bonds

International Equities: Conflict stalls performance, drivers in place

10. What’s the investment case to allocate to international stocks this year?

The beginning of 2026 saw a continuation of 2025’s international equity outperformance, with foreign stocks returning 11.4% through February, beating the U.S. stock market’s 0.7%. That outperformance was primarily driven by a weaker U.S. dollar and greater appetite for diversification, as well as strong earnings growth and accelerating AI-buildout demand, particularly in emerging markets.

But performance has weakened since the onset of the conflict in Iran in late February, with international equities down 10.7% in March.²² We believe the structural return drivers for international equities remain in place, however. While the dollar has strengthened recently, we see the Fed as better positioned to hold or cut rates given its dual mandate of full employment and price stability, while other central banks may need to hike rates to fight inflation – potentially leading to dollar weakness.

Additionally, emerging market earnings growth has been robust (Figure 10), driven by demand for semiconductors and compute, essential inputs for the AI buildout, and a trend we see as only beginning.

Critically, 75% of the world’s chip manufacturing is centered in East Asia.²³ Resource-rich Latin American countries such as Brazil may also be set to benefit amid rising demand for rare earth minerals, which are used in chip manufacturing. Earnings growth expectations for EM is 28%, up from 12% in mid-2025, while selling driven by the recent energy shock has compressed multiples to the lowest levels in a year.²⁴

Euro area growth has not been as robust as EM, but we see opportunities for diversification away from tech-heavy portfolios into sectors such as financials and industrials, potentially benefiting from higher rates and increased defense spending.

Figure 10: YTD total return decomposition

Portfolio Insights: Look to liquid alts for diversification

11. Why was gold down in March?

The recent spike in volatility has led to a rarity in asset performance, with simultaneous declines across equities, fixed income, and gold.²⁵ This reflects a repricing of macro risks rather than a single shock. The escalation in the Middle East pushed oil prices above $100 per barrel, reinforcing inflation concerns and leading markets to push back expectations for policy easing.²⁶ This lifted bond yields, weighing on fixed income returns, while higher real yields and uncertainty around growth have pressured equities.

Higher real rates and a stronger U.S. dollar have also suppressed gold’s performance.²⁷ Regional disruptions, including impacts from the closure of the Strait of Hormuz, alongside profit-taking after strong inflows, have added to gold’s pullback. Even so, we continue to believe in the structural case for gold. With cleaner positioning and more attractive entry levels, we favor gold as a diversified allocation in portfolios, particularly around potential debasement risks.

More broadly, we believe that more frequent bouts of volatility call for owning a broader basket of hedges in commodities and in other alternative assets to capture a wider set of diversifiers.

Figure 11: Gold has provided ballast in down months for stocks

12. What assets have provided diversification so far in 2026?

Traditional stock-bond diversification has been unreliable in recent years and weakened meaningfully following the onset of the Middle East conflict in late February. The 20-day rolling stock-bond correlation rose to 0.72 in late March, its highest level since May 2024.²⁸

Amid unreliable correlations and in a year where the traditional 60/40 portfolio has struggled, liquid alternative strategies are attracting attention. These strategies use techniques such as long/short, derivatives, and market neutral investing to seek returns with low correlations to traditional assets. Crucially, these strategies are often lowly correlated with each other, making them key building blocks in portfolio of diversified diversifiers.

While stocks and bonds have both been moving in the same direction for much of this year, liquid alternatives have done their job, delivering positive returns with lower annualized volatility than stocks.²⁹ Amid elevated dispersion, rising stock–bond correlations, and geopolitical uncertainty, these strategies have benefited from a cross-sectional approach, going long expected outperformers and short underperformers to seek returns from relative value rather than market direction. This structure enables them to remain market neutral, with low beta to traditional assets, resulting in low correlations to both stocks and bonds and more stable return profiles.

As a result, strategies such as market neutral have provided meaningful diversification and downside resilience during recent market turbulence, as shown in Figure 12. This pattern has held up in recent history, as the market neutral strategy has posted positive returns 60% of the time during down months for stocks from 2020–2025, outperforming gold (40%) and bonds (24%) as a buffer on the downside.³⁰

Investors have taken notice. Financial advisors and institutional clients consider liquid alts as a credible portfolio diversifier, selected by over 20% of polling respondents in March, and interest in liquid alts as a diversifier has jumped by half since the start of the Middle East conflict in late February.³¹

Figure 12: Liquid alternatives have delivered strong returns compared to stocks and bonds with lower volatility

13. How are financial advisors positioning their portfolios right now?

Clients are turning more risk-on following the announcement of the ceasefire in the Middle East. Our latest polling shows 42% of investors are neutral, while bullish sentiment (40%) now outweighs bearish (17%), after bearish briefly outweighed bullish in March.

U.S. equities have risen to be the highest conviction net allocation overall, even if demand differs among client-types. Advisors are also leaning into U.S. equities (+20% net), while demand among institutional clients is essentially flat (+0.56%). Investors are primarily funding using cash, with a net reduction rate of -12%. Alternatives see the most consistent demand for additions among both client types.³²

Despite strong interest in alternatives, advisors remain under allocated. The average allocation among advisors who hold alternatives is ~7%, only 52% of moderate-risk portfolios include alternatives, highlighting potential room for further adoption.³³

ETF flows underscore the cautious shift. Equity inflows slowed to $64 billion in March, with about 90% into active strategies, while fixed income captured over 75% of flows early in the month. More than half of fixed income flows moved into ultra-short and short-duration exposures.³⁴

Figure 13: Planned asset class moves differ among client-type