Playing the Long Game Amid Risk Market Turbulence

Among the factors driving equity market swings recently and since summer, monetary policy – and very recently, the fear of a misstep in monetary policy – has been particularly powerful.

Last week was particularly bruising, with pronounced swings lower in some corners of financial markets.

U.S. cyclical stocks have erased much of their post-summer rally relative to defensive stocks, and under the hood, technology stocks and consumer discretionary have been especially weak, notwithstanding punchy earnings from Nvidia and a broadly decent sweep of U.S. macro data, respectively.

From the bird’s eye view of an asset allocator, cross-asset volatility is also higher, though not alarmingly so. For example, equity, rates and oil volatility (as measured by the VIX, MOVE and OVX indexes, respectively) have retraced half (or just over half) of where they were at the peaks of the ‘liberation day’ sell-off in early April.

It also has not been ‘all risk off’: government bonds haven’t meaningfully rallied (Japanese bonds have in fact sold off, pushing long-end yields to post-Global Financial Crisis highs), index credit spreads remain generally contained, and areas like emerging markets have outperformed.

Fears Around a (Near-Term) Policy Misstep

In our view, fears around a near-term Federal Reserve ‘policy mistake’, akin to say late 2018, have been an important factor driving markets recently. Current odds—at less than 40%—of a December rate cut being priced into Fed Funds futures are at the lowest since March. Just four weeks ago, a 25bp rate cut was fully baked-in, at 100%.

As the odds of a December rate cut have been rapidly pared back, so, too, have equity prices, especially those more sensitive to domestic policy rates. The recent sell-off in Home Depot, for example, began around 48 hours after expectations of a Fed rate cut in December peaked in mid-October on a ‘Powell pivot’, and accelerated more recently on weak earnings—and more hawkish Fed commentary.

While other factors have been at play, including concerns around credit and returns on invested AI capex, policy has been a chief driver of market returns more broadly for much of 2025.

A simple Principal Component Analysis (PCA) model comprised of 20 cross-market variables distilled into growth, inflation and policy demonstrates how expectations around monetary policy both underpinned the post-summer rally in risk assets, and has driven the recent sell-off.

Market-implied growth has softened gradually, consistent with soft labor indicators, but resilient GDP and consumer spending data have precluded a deeper slowdown being priced in. And, despite a notable increase in effective U.S. tariff rates, market-implied inflation has stood broadly pat this year, with only a modest uptick since August.

Playing the Long Game

Notably, what has been taken away for December has been more than given back for 2026. To be sure, as December rate cut expectations have been clipped back, more meaningful monetary easing has been priced for 2026—around 90bps at the time of writing, 20bp more than a fortnight ago. And insofar as we and markets expect the Fed to cut into firm and even rising economic and earnings growth over the course of 2026, a policy-induced sell-off should be short-lived, creating an opportunity to play the long game.

Rates pivoting lower without recession tends to be positive for stocks, and nominal GDP growth above 4% tends to limit bear market risks. Importantly, notwithstanding data gaps from the U.S. government shutdown, current and leading indicators signal recovery, not recession, for the U.S. And the combination of productivity-led gains (and resulting inflation-light growth) with weaker labor allows for easier policy, especially monetary policy.

This in turn sets a constructive backdrop for risk assets, and indeed longer-duration fixed income where negative carry positions turn positive as the Fed eases. We would seek to use periods of market weakness to lean into favored positions in both equities and fixed income.

Cash Flows and Discount Rates

For the most part, expected returns from being long an asset, excluding commodities of the major blocs, tend to be a function of two things: anticipated cash flows and the discount rate applied to those cash flows. Although stock markets are emphatically not the economy, firm nominal growth tends to equal firm nominal corporate earnings.

On cue, the third-quarter corporate earnings season in the U.S. revealed 12% EPS growth for the S&P 493 stocks (ex. the ‘Mag 7’ mega-cap technology companies), the fastest clip since Q2 2022. Strikingly, and unlike 2022 when earnings for the Mag 7 companies were contracting by mid-double digits, Mag 7 earnings also continue to grow: a healthy 23% was reported for Q3 2025.

A high conviction view held by our Asset Allocation Committee has been an expected broadening out of equity markets as earnings prospects converged. This has evolved from the Mag 7 to the S&P 493 a year ago, to Europe, Japan and emerging markets over the course of 2025. And while we have recently moved Europe back to at-target, we continue to favor index and key equity sector exposure in Japan and select emerging markets.

To be sure, in comparing areas such as IT, communication services or even industrials, performance in markets including Japan, China and Korea (particularly) have dwarfed the U.S. in both equal-weighted and market cap terms by sector. And these remain our favored areas to gain market exposure.