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Thought of the day

What happened?
Equities and bonds across the world fell on Tuesday, prompted by an escalation in geopolitical tensions over Greenland and concerns over Japanese fiscal policy.

Over the weekend, US President Donald Trump threatened to impose escalating tariffs on eight European countries until the US is allowed to buy Greenland. The EU is reported to be considering retaliatory measures, potentially including tariffs or restricting access to the EU single market for US companies. Ahead of a speech in Davos on Wednesday, Trump said on social media that there was “no going back” on his goal to control Greenland.

Fears of prolonged uncertainty and the prospect of a resumption of a US/EU trade war weighed on equities. The US S&P 500 closed 2.1% lower and Europe’s Stoxx 600 closed 0.7% lower. On Wednesday, major Asian indices closed a mixed session, with Japan's Topix ending down 1% but both onshore and offshore Chinese equity markets closing with gains. Furthermore, the declines on Tuesday came after rallies of around 15% for the S&P 500 and 19% for the Stoxx 600 over the past year.

Notably, the US dollar also fell sharply, with the DXY dollar index depreciating 0.8% on Tuesday (and trading flat at publication time on Wednesday), in contrast to its historical tendency to appreciate during times of heightened volatility. Investors turned to other perceived “safe havens,” with gold rallying to reach a fresh record high, and the Swiss franc appreciating by 0.9% against the US dollar on Tuesday. At the time of writing, gold had advanced another 2.2% in the Wednesday European session, trading at USD 4,868/oz.

Meanwhile, Japanese Prime Minister Sanae Takaichi formally dissolved the lower house of the National Diet on Monday for a snap election scheduled for 8 February. Durin g a press conference, she pledged to cut the consumption tax on food, strengthen national security, and increase investment in various sectors. Japanese government bond (JGB) yields rose on the news, amid fiscal concerns.

The rise in JGB yields stabilized on Wednesday, but the 10-year yield is still up 12 basis points this week to 2.31%, while the 40-year yield has increased by some 30 points to 4.11%. This contributed to negative sentiment toward government bonds around the world as investors worried about the potential for repatriation flows as Japanese yields become more attractive to domestic investors. Yields on 10-year US Treasuries increased by 7bps to 4.29%, up from a low last week of 4.14%.

What do we expect from here?
The impact of geopolitical events on financial markets, including the US strike against Iranian nuclear facilities and the arrest of Venezuela’s President Maduro, has tended to be smaller when the resolution is quick and conclusive.

We are therefore monitoring for the risk of a prolonged standoff or a retaliatory tariff escalation between the US and Greenland/Denmark/the EU. Both sides exerting economic and political pressure on one another would, in our view, have the most damaging effect on risk assets—in particular in Europe.

A more benign potential resolution would be for the Trump administration to establish free military and resource access, but without acquiring Greenland. Experience from last year shows that the Trump administration is prepared to negotiate and dial back tariffs from initially imposed levels.

Though we are mindful of the potential for further short-term volatility, our base case is that tensions over Greenland are not a reason to change our overall positive view toward risk assets. This geopolitical uncertainty supports broadening out equity exposure across regions, sectors, and structural themes, in our view. Next month’s Supreme Court judgment on the use of IEEPA tariffs could also hamper Trump’s ability to impose fresh tariffs, if deemed unlawful.

Meanwhile, the recent sell-off in longer-term government bonds in Japan and the US demonstrates the kind of pressures that can arise when fiscal policy is questioned. But if long-term bond yields continue to rise, we would expect a combination of adjustments to bond issuance and potential central bank intervention to keep yields contained. After initial volatility, this would be a positive for the bond market but could lead to higher volatility in currencies. Our June forecasts for 10-year government bond yields in the US and Japan, of 3.75% and 2.00%, respectively, are below current levels.

How do we invest?
Add to equities. We continue to believe a positive global growth outlook provides a favorable backdrop for stocks in 2026. Real GDP growth is one of the most important macro drivers for equity markets and the four largest economies in the world are all in fiscal expansion mode. Solid economic growth in turn should bode well for corporate profits. We expect S&P 500 earnings per share to increase by 12% this year, compared to our 2025 estimate of 11%, and profit growth is also gathering pace elsewhere in the world.

Although a US/EU trade war poses risk, an increased need for European nations to boost defense spending and a stronger focus on sourcing military equipment from within the region should support European defense stocks.

Investors who are underallocated to stocks can use periods of volatility to build "shopping lists" of regions, sectors, and companies they might like to own to broaden their sources of return and diversification. Higher volatility may also increase the appeal of certain structured strategies that generate income while allowing investors to buy stocks at lower prices than today's.

Seek diversified income. We continue to believe quality bonds—specifically high grade government and investment grade corporate bonds—have an important role as a source of yield and diversification in 2026. We expect medium-duration quality bonds (four to seven years) to deliver mid-single-digit returns from a mix of yield and capital appreciation as the Federal Reserve cuts rates. We believe volatility in yields on the back of current fiscal and geopolitical concerns represents an opportunity for underallocated investors to add exposure.

Favor commodities. Gold is continuing to prove an effective hedge against rising geopolitical tensions. We prefer gold to other precious metals for this purpose, as its price is less affected by industrial demand cycles and benefits from persistent demand from central banks for reserve diversification. More generally, we believe commodities are set to play a more prominent role in portfolios in 2026, with returns across industrial and precious metals driven by supply-demand imbalances, structural demand, geopolitical risks, and fears about monetary debasement. We forecast gold to reach USD 5,000/oz by end-March, but foresee a rally to USD 5,400/oz if geopolitical risks intensify.

Hedge market risks. On top of maintaining a diversified portfolio and exposure to gold investors can also consider substituting direct equity exposure for capital preservation strategies. These strategies can often limit the risk of losses while allowing some participation in any market rebound. While returns may be capped in strong markets, such strategies reduce drawdowns and support long-term wealth preservation. Replacing some direct equity positions with these strategies can make portfolios more resilient to volatility and shocks. As well as looking for direct hedges, diversifying with alternatives can provide a source of less correlated returns, which is particularly useful when stocks and bonds are moving in tandem.