The “everything rally” is here. From technology stocks to gold and cryptocurrencies, risk assets have shot through the roof in 2025. This extraordinary melt-up is set to persist as the Fed embarks on monetary easing, with the futures market pricing in nearly five rate cuts by end-2026. It is a curious irony that investors are showing such exuberance at a time when the US effective tariff rate has reached a historical high since the 1930s, posing detrimental implications for corporate profitability and domestic consumption in the months ahead. Above all, this rally is also unfolding just as Trump’s One Big Beautiful Bill has reignited US fiscal profligacy concerns, driving long-term Treasury yields higher while plummeting the dollar.

A road less travelled. As US government debt exceeds 120% of GDP, it is obvious that the administration requires lower rates to fund the cost of servicing its gargantuan debt. Given spiralling deficits and Trump’s frequent demands for the Fed to lower rates and bend monetary policy to his will, the threat of fiscal dominance is a clear and present danger. In such a regime, the government’s fiscal requirements take precedence. Should policies result in rising debt, the central bank will be obliged to accommodate, either by cutting rates or through debt monetisation. In short, the Fed’s dual mandate of employment and price stability will become secondary to the government’s fiscal needs.

Historically, fiscal dominance is more widely associated with emerging economies, following a familiar cycle like this: Excessive government spending funded by central bank money printing, leading to periods of hyperinflation, subsequent currency devaluation, and ultimately, the loss of central bank independence. Today, the story has evolved – this phenomenon is no longer confined to emerging economies. The US, through years of fiscal largesse, is similarly facing rising debt levels that require low rates for interest servicing. But this approach is problematic. While the Fed controls the short end of the yield curve, the long end is dictated by market forces, and the divergent path we currently see reflects waning confidence on the central bank’s ability to anchor inflation expectations.

It is said that history does not repeat itself, but it often rhymes. As we stand at the precipice of yet another episode of fiscal dominance, the US experience during WWII serves as a cautionary tale. Back then, the Fed capped interest rates to fund the war effort. This eventually translated to hyperinflation after the war, prompting the central bank to forge the Treasury-Fed Accord in 1951, which restored central bank independence. Today, 80 years after the end of the Second World War, the Fed’s credibility is once again on the line. Granted, the central bank can, in theory, print its way out of trouble via debt monetisation. But bond vigilantes will demand higher yields if they deem the central bank to be losing control of inflation. Based on the current trajectory of US fiscal spending and the limited progress made at DOGE, it is difficult to imagine the deficit situation in the US improving anytime soon.

Resurgence of stagflation-lite headwinds. Fiscal dominance aside, another topic that will likely dominate the narrative in the coming quarters is the resurgence of stagflation-lite headwinds, as negative impact from Trump’s “beautiful tariff” simmers. Incoming macro data and official forecasts are pointing in this direction. For instance, US employment numbers for May and June have undergone sharp downward revisions while the uptrend in prices (within ISM services) suggests broad-based inflation is creeping in. The Fed’s Summary of Economic Projections in June flagged rising stagflation risks, a view echoed by private forecasters. In a recent Bank of America survey, 70% of global investors surveyed expect stagflation over the next 12 months.

So, given these macro headwinds, what is underpinning the sharp risk-on mood in markets? Clearly, investors are looking at the glass half full rather than half empty. Fuelled by optimism around the transformational qualities of AI and its impact on corporate profitability, the street is pricing in robust earnings growth of more than 10% for 2025 and 2026, compared to an average of 3% in the prior two years. Strong earnings growth expectations, overlaid with falling policy uncertainties and Fed monetary easing, have set the stage for risk assets that are currently “priced-for-perfection”.

Our “Greed & Fear” indicator, which gauges investor sentiment and positioning, is currently hovering near the upper bound of “Greed”. This suggests sentiment is nearing an extreme, and a correction is on the cards should incoming data disappoint. Under such circumstance, portfolio diversification and downside protection are key. For the forthcoming quarter, numerous signs point to potential fragility in the current rally:

• Overconcentration risk
• Valuation risk
• Earnings risk

Market Fragility Signal I: Overconcentration risk. A major concern in the ongoing rally is overconcentration risk – a situation where the largest companies account for a disproportionate share of the total market map. Currently, the top ten largest companies – including the likes of Nvidia, Microsoft, and Apple – constitute 38% of the S&P 500, a significantly larger figure compared to 20% in 1995, when the ten largest companies included names such as General Electric, AT&T, and ExxonMobil.

Overconcentration of large-cap companies brings substantial fragility to the current rally as the index becomes susceptible to sharp corrections should companies fail to deliver on the earnings front. A clear case in point is the optimism surrounding AI. While companies have committed huge capex to the new technology in aggregate, a recent MIT report suggests that 95% may find zero returns on their AI investments. Given the heavy concentration of Big Tech firms leading this charge, such a prognosis is, to say the least, concerning.

Market Fragility Signal II: Valuation risk. Valuation is driven by two factors: (1) share price movement and (2) forecasted earnings. Since the trough of “Liberation Day”, risk assets – both equities and credit – have rallied sharply as investors priced in falling policy risks and impending Fed monetary easing. However, the optimism displayed by investors is unfortunately not matched by actual fundamentals. In the equities space, earnings forecasts have remained flat as analysts remain cautious in their assessment of how tariffs will impact corporate earnings, given limited guidance from company CFOs.

Rising equity prices and range-bound forecasted earnings have translated to a spike in valuations. At the current level of 24.3x forward P/E (using the S&P 500 as proxy), valuation is edging close to the +2 SD mark, suggesting that equities are currently looking expensive. The same sign of exuberance is evident in the corporate credit market as spreads have tightened to 79 bps (close to the -2 SD tight mark), which came on the back of robust corporate balance sheets and additional tailwind from tax cuts.

Market Fragility Signal III: Earnings risk. An often-cited distinction between the dot-com bubble and recent tech-fuelled rallies is this: unlike the dot-com era, today’s rally is driven by profitable companies that are actually cash-flow positive. This is true to some extent – no one can deny the strong earnings prowess of Big Tech. But outside of this space, cracks are starting to emerge:

• Earnings growth momentum for the S&P 500 ex-technology, for instance, is showing signs of tapering after a strong rebound from the Jul 2023 trough.
• Within the tech space, unprofitable companies are expected to remain in the red through 2026. Yet, this has not stopped them from rallying in line with the rest of the market.

We have long maintained that the tariff income currently enjoyed by the US government must be funded somewhere – either from consumers’ pockets or by importers of foreign goods in the US. There is no free lunch. It is reasonable to assume that importers will eventually absorb some of the pain and that’s when margin compression and earnings downgrades take place.

Portfolio Diversification: The Only Free Lunch

The probability of a further melt-up in risk assets remains high, given the trifecta of Fed easing, “Goldilocks” macro conditions, and AI-related capex tailwinds. However, we are also cognisant that this rally is taking place at a time when policy uncertainties and fiscal concerns dominate. With investors caught between a rock and a hard place, our strategy for investors is to ride the rally but protect your downside through portfolio diversification.

For 4Q25, our key market calls are:

• Double-down on our conviction in US technology and raise our weighting for US equities to neutral
• Add positions in Asia ex-Japan to capture upside momentum from Fed monetary easing
• Hedge portfolio downside with exposure to gold, hedge funds, and private assets

Add positions in US technology and raise US equities to neutral. Riding on the back of AI-related capex optimism and earnings upgrades, US technology stocks have been leading the gains on the S&P 500 this year. On a YTD basis, forecasted earnings for AI-related stocks (using the Bloomberg Artificial Intelligence index as proxy) have been revised up by 34 %pts (vs 12% for the broader market). We expect this positive momentum to persist as AI adoption gains pace. We advocate adding positions in US technology, and by extension, bring our overall weighting in US equities to neutral.

Add positions in Asia ex-Japan. Beyond technology, we also advocate for investors to add positions in AxJ. Indeed, our overweight view on AxJ is reaping dividends: on a YTD basis, the region has outperformed developed markets, with robust performance in China, Hong Kong, and Korea. We expect the positive momentum to persist, given:

• Persistent dollar weakness, which historically translates to Asia’s outperformance
• Funds flow momentum improving by the margin. Based on data from EPFR Global, AxJ flows accounted for 1.1% of global flows in 7M25, while its share has rebounded to 3.5% in August
• Valuation advantage, with AxJ equities trading at a 28% discount to developed markets and the market serving as an important alternative for investors looking to diversify from crowded trades

Overweight gold, hedge funds, and private assets. To hedge against portfolio drawdowns, we advocate adding exposure to gold. The precious metal has recently broken out decisively above the USD3,400/troy ounce mark as dollar weakness and expectations of Fed rate cut gather pace. We believe that the longer-term upside remains intact as prevailing concerns on US debt sustainability underpin central banks’ shift away from US Treasuries into alternate reserve assets like gold.

Since 2015, gold’s share of total international reserves has increased from 9.1% to 21.8% as of 2Q25, largely at the expense of US Treasuries, which registered declining percentage share over this period. In the alternatives space, quantitative analysis by our private assets analysts suggests that a hybrid portfolio that includes a fund of open-ended funds offers better diversification – outperforming the traditional 60/40 portfolio over a 10Y horizon.

4Q25 Asset Allocation – Optimal Risk-Reward

Cross Assets – Bonds remain in play. The latest scoring on our CAA framework suggests a preference for bonds over equities.

Fundamentals: Despite tariff headwinds, the US economy continues to display broad-based resilience, evident from recent ISM and retail sales numbers which suggests no signs of an extreme slowdown in economic activities. The Atlanta Fed GDPNow is forecasting growth of c.3%, in-line with the growth trend seen since 2022. While jobs growth has moderated somewhat, wage growth remains resilient. On the corporate earnings front, the street is expecting a 12% US earnings growth for 2026, supported by a 6.2% revenue growth and EBITDA margin expansion of 1.6 %pts to 23.4%.

Valuation: The gap between the US earnings yield and the UST 10Y yield has deteriorated to -0.5% (as of 2 Sep), reinforcing our preference for bonds over equities.

Momentum: Fund flow momentum for equities continues to moderate with USD53bn entering this space in 3Q (as of 27 Aug) and this stands in contrast to the inflows of USD199bn for bonds.

Clearly, investors are adopting a wait-and-see stance as they assess the full impact of tariffs on corporate earnings. In contrast, bonds offer attractive yields at this juncture, notwithstanding its defensive qualities that will help cushion portfolio downside during periods of market drawdowns.

Equities: Adding exposure to technology and shifting US equities to neutral; Seek opportunities in Asia ex-Japan. The start of a new rate-cutting cycle by the US Federal Reserve will underpin further upside for global equities in the final months of 2025. But unlike the rally that followed the “Liberation Day” sell-off (which saw markets rising across the board), the impending upcycle will likely be more targeted and less indiscriminate – for one simple reason: valuations are no longer cheap.

Indeed, global equities currently trade at c.16% above their 10Y average (on a forward P/E basis), with premium valuations driven by developed markets, notably in the US. We are currently in an environment where risk assets are “priced for perfection”, with assumptions of Fed accommodation and macro resilience baked into analysts’ forecasts. However, such assumptions leave markets vulnerable to acute profit-taking should jobs or inflation data disappoint in the coming months.

To maximise risk-reward, we advise investors to stay nimble and adopt a “barbell” approach by taking extreme positionings in both growth and value exposures. From a growth standpoint, we advocate adding exposure to US technology. Despite tariff headwinds, technology companies have reported strong earnings and robust forward guidance, underlining their resilience. As the adoption of AI accelerates, we expect the surge in technology investments to sustain earnings momentum, which augers well for the outlook of the sector.

In terms of value play, Asia ex-Japan comes to mind. At 15.6x forward P/E, the region trades at a 28% discount to developed markets, offering a margin of safety for investors during episodes of market sell-offs. Above all, persistent dollar weakness will lend further tailwinds for the market, given the sharp inverse relationship between the US Dollar Index (DXY) and AxJ equities.

Our Asia strategists believe that corporate earnings in populous economies such as China, India, and Indonesia, as well as technology-oriented markets like Korea are poised for positive surprises. Based on consensus forecasts, the street expects 17% average earnings growth for these markets, well above the 11% growth projected for developed markets.

To fund our addition of weights in US technology and AxJ equities, we are downgrading Europe to neutral and Japan to underweight on a 3-month basis.

Bonds: Maintain cautious view on ultra-long bonds; prefer IG credit over govvies. The combination of a softening US labour market and unrelenting political pressure has compelled the Fed to thread the path of least resistance and begin its rate-cutting cycle. However, with tariff-induced inflationary pressures gradually showing up in macro data, this move will no doubt trigger concerns over Fed independence and credibility. Rising long-term yields and a steepening yield curve are clear signs that investors are losing confidence on the Fed’s ability to control inflation further down the road. In this environment, we maintain a cautious view on ultra-long bonds.

On a relative basis, we maintain our preference for corporate credit over govvies given that US companies are poised to benefit from tax cuts which bolster their balance sheets. Govvies, on the other hand, face perpetual headwinds from fiscal deficits and rising government indebtedness. That said, we are cognisant that credit spreads are currently near historical tights, but for good reasons:

• Expectations of impending rate cuts have compelled corporates to delay bond issuance in hopes of lower financing costs further down the road, resulting in a demand-supply mismatch.
• The Fed’s intervention in the credit market during the pandemic has created a perception of “Fed put” in pay, leading to a compression of premiums.

In terms of portfolio strategy, we maintain our preference for quality in the A/BBB space and continue to see better value in IG credit over HY.

Alternatives: Overweight real assets as US embarks on twin easing (fiscal and monetary); favour private infrastructure and gold. In a polarising world marked by rising volatility and geopolitical uncertainties, the role of alternatives in portfolio construction has never been more important. Our quantitative analysis shows that a hybrid portfolio consisting of semi-liquid private assets and hedge fund strategies outperforms a pure equity play as well as traditional 60/40 equity-bond portfolio over a 10-year period. Now, as the US embarks on twin easing – both monetary and fiscal – inflation is poised to rise in the years ahead, translating to rising demand for real assets such as private infrastructure and gold.

Private infrastructure assets possess two unique qualities that allow investors to generate inflation-protected distributions and hedge against rising inflation: (1) it possesses inflation-linked revenue structures and (2) cash flows are contracted and long-term in nature.

We favour infrastructure assets with low elasticity in demand, such as utilities, which allow service providers to pass inflation-driven cost increases on to end users.

The recent breakout in gold prices beyond the USD3,400/troy ounce mark reflects more than just rising inflationary concerns; it signals growing investor unease over global geopolitical tensions, Fed independence, and de-dollarisation. Gold remains a crucial component of portfolio construction and based on the current pace of central bank purchases, we expect gold prices to hit USD4,450/troy ounce in 1H26.