Key Takeaways
- Tactical adjustments. We maintain a slightly conservative approach relative to strategic allocations in U.S. large cap equities and credit risk alternatives given what we perceive may be limited upside relative to risk. We also revert to strategic targets for growth and value styles in U.S. Large Cap and Developed non-U.S.
- Discipline. On one hand, equity valuations are lingering at lofty heights. On the other hand, market momentum has rarely been stronger. It makes for a challenging environment for investors. Those with a valuation mindset anxiously await a correction, while those that believe in the growth potential of the latest technology cycle believe prices can keep going. Times like these tempt investors into making more radical shifts. However, we believe that having a sound discipline and tools to evaluate markets in a non-emotional manner are critical in these periods.
- Earnings momentum. Corrections can happen at any time, but more significant drawdowns usually occur in recessionary periods . Fiscal stimulus from governments around the world, a technology race in artificial intelligence, and falling interest rates support earnings growth. If that persists, or at least doesn’t disappoint, there is unlikely to be a significant and lasting drawdown.
- Storm watch. Key items to look out for that may indicate a change in the current trajectory: (1) a more significant slip in unemployment; (2) deterioration in consumer/household spending including defaults on auto, credit-card and student loans; (3) a slowdown in the pace of capital expenditures among the so-called “Hyperscalers” (Microsoft, Amazon, Google, Meta, OpenAI, etc.); and (4) flare-ups in trade and tariff negotiations.
The Macro Picture
Investors are currently facing various geopolitical and macroeconomic uncertainties along with elevated valuations for the S&P 500 Index, which represents over 80% of U.S. equity market capitalization and about 50% of global equity market capitalization. This environment poses notable difficulties for those who emphasize valuation considerations. On the other hand, growth-oriented investors identify the potential revolutionary impact of technological advancements led by artificial intelligence that may not be fully captured by current valuations.
It is easy to let emotions creep into decision-making at times like these. Some investors we speak with today say “it is so obvious that things are overvalued, a correction is coming,” while others say, “the opportunities are so obvious, now is the time to invest.” For those who prefer not to end up with an all-or-nothing outcome, there are some basic rules that we recommend: (1) diversify; (2) regularly rebalance; and (3) use a consistent, systematic approach to evaluating market conditions and valuations.
What do the tools that make up our systematic approach tell us today?
- US Large Cap equities are overvalued based on historical averages[1]. Most other equity markets are not. This includes US Small Caps, Developed Non-US and Emerging Market equities.
- Our Market Cycle Dashboard[2] tool, which measures a broad range of factors across economic, credit, valuation, momentum and sentiment data points, indicates that there is not currently a heightened risk of recession.
- Momentum remains quite strong for equity markets and is often a better indicator of short-term performance than valuations.
United States. The US Government is currently shut down (as of October 27, 2025). The Fed is in an unenviable position of balancing a softening labor market with higher-than-desired inflation. Prices of equities are arguably quite rich. Credit spreads are tight. But in the end, market participants seem only to care about the trajectory of earnings and the fact that they are forecast to grow at above-average rates.
Artificial intelligence is not only capturing much of the media attention, but also most new venture capital investments as well. Beyond AI, there are many other technological innovations that could dramatically change the makeup of our economy including quantum computing, space exploration, blockchain technology, self-driving (and flying) vehicles, robotics, battery technology/energy storage, etc. These changes may introduce costs for existing businesses that new enterprises may be able to leapfrog altogether. How might traditional banking, real estate, insurance, energy, and other industries be challenged in the years ahead? Are these “old economy” businesses destined to be replaced, or will they adopt new technology and come out stronger for it?
Europe and Asia. Let’s start by celebrating the returns so far in 2025, which have been led by regions outside the US. These markets had been all but dismissed due to their slower growth and demographic and fiscal challenges, not to mention lack of innovation. Nonetheless, these have been better performers than the US markets. Still, valuations remain much closer to their historical averages and therefore more attractive compared to U.S. Large Cap equities. Forward earnings growth expectations have slowly been catching up with their US counterparts.[3]
Emerging markets has been one of the leaders in performance in 2025, with strong contributions from South Korea, Taiwan, China, Brazil, and Poland[4]. AI-related trades, supply-chain adjustments and the ongoing Russia/Ukraine war have all impacted these outcomes. China is seen as one of the only competitors with the US in the AI race, and trade tensions between the two remain high. Nonetheless, investors are generally willing to go wherever they can make a return and EM equities have been a bright spot this year. Developments in technology and adjustments to the supply chain may lead to new/different winners in the years ahead—yet another reason to consider the use of active investment managers in the emerging markets.
Fixed Income. Rate cuts in the US have been slower than hoped for and we must question whether they will go as far as previously forecast, particularly with inflation remaining sticky near the 3% level. There is very little premium to be found for accepting duration and credit risk in the current market, another sign that market participants generally expect smooth sailing from here. There have been more headlines about currency debasement and the commensurate increase in the price of gold, but fixed income markets do not seem to corroborate that story. A 4% yield for funds parked in money market vehicles is satiating to many who might be nervous about the current environment. Barring a recession, we expect the longer end of the yield curve to remain relatively anchored, while there is still some room for the short end to come down, making for more difficult choices for money market investors in the months/quarters ahead.
This is a summary of our full Tactical Allocation Viewpoints report, which includes detail on Pathstone’s current recommended allocations by asset class and sub-class.
