Equities

German stocks trail their peers in the fourth quarter

Despite several setbacks, global equity benchmarks posted further gains in the fourth quarter. However, German stocks underperformed other indices. A stronger euro, softer economic data and, above all, a significant correction among defence companies weighed on the performance of the DAX. Nevertheless, pan-European stock indices rose by almost 4% in this quarter, also because defensive sectors such as healthcare gained some ground. Concerns about excessive valuations in the technology sector, combined with somewhat more hawkish expectations regarding the Federal Reserve (Fed), led to a short-lived market correction in US stocks in November. For euro investors, this was somewhat cushioned by an appreciation of the dollar. Emerging market equities proved to be a good portfolio diversifier and generated solid returns over the last three months.

US equities are likely to continue their rally in 2026

Analysts have once again significantly raised their earnings expectations for US equities over the past 3 months. The market now forecasts an earnings growth rate of 14% for S&P 500 companies in 2026, following already 12% in 2025. You can’t really blame equity analysts for this. At least on paper, there is no reason to believe that the earnings growth frenzy in US stocks will take a breather next year. The combination of lower interest rates, a Trump administration that is likely to pull out all the policy stops to ensure a good result in the upcoming midterm elections, as well as solid US profit margins that could expand further thanks to AI-driven savings paint a positive picture for US equities in 2026.

But already high expectations limit the upside potential

However, the market backdrop for US equities is not quite as upbeat as it may seem. Very expensive US valuations and structurally higher equity positioning from individual investors suggest that at least some of the positive drivers mentioned above are already in the price. A more sluggish US economy or fewer interest rate cuts by the Fed, as our economists expect, could ultimately cause the rally in US equities to be weaker than the very bullish market consensus currently seems to expect. There is also the risk of a second Deepseek moment – i.e. the emergence of even more high-quality AI competition in China. Given these risks, it’s more important than ever for us to maintain broad regional and sector diversification in the coming year.

High US valuations make diversification more attractive

Indeed, European and EM equities are valued much more favourably than their US counterparts and also in comparison to their own history. Earnings revisions, which have recently continued to rise for US equities, were also significantly weaker in Europe. Such lower expectations, combined with regional growth drivers such as the economic stimulus package being rolled out in Germany, the peace negotiations in Ukraine, Beijing's new five-year plan, and the increasingly dominant role that Asian economies are playing in the ‘AI boom’ make both EM and European stock markets interesting as regional diversifiers in 2026 as well. On a sector level, pharmaceutical and commodity stocks are likely to play a much greater role in 2026 than in previous years. Both segments have more attractive valuations and lower positioning levels compared to the overall market. At the same time, they could offer investors a degree of diversification should the market consensus proves to be wrong and rising inflation momentum prompt central banks to adopt a less expansionary monetary policy.

Although 2026 is likely to be another positive year for equities, the already very high market expectations are limiting the upside potential for the coming year. We therefore expect the equity bull market to continue in 2026, but to be less pronounced than in previous years. In the long term, high valuations are likely to weigh on the return potential of US equities.