Imagine if they had Polymarket and Kalshi 150 years ago. What a time the speculators of the day would have had! In 1876, major disturbances broke out all over the Balkans as people rose up, in a generally sporadic and uncoordinated fashion, against their nominal overlords running the Ottoman Empire. An uprising in Bulgaria was particularly brutal as a small band of nationalists was crushed by Ottoman troops and massacred in grisly fashion. These disturbances worried the Great Powers of the day, with Russia and newly-united Germany in particular swooping in to either try and restore order or grab a bit of land and influence where the opportunity presented itself. Serbia and Bosnia were also waking up to nationalist sentiments that would reach fever pitch in the years to come.

Prediction Markets Mania

Of course, there was no such thing as digital prediction market platforms back in the 1870s, so there was no way for, say a Vienna-based punter to make an overnight killing on the likelihood that the Ottomans would accept the establishment of an independent Bulgaria, or the odds of a Bosnian revolt against the administration of their affairs by Austria-Hungary. Today, though, these user-friendly market platforms are in full swing as the Western world reverts to the mores of Great Power politics.

And what happens on prediction platforms like Polymarket doesn’t stay on Polymarket, but jumps like a charged electron up a level or two to exert pressure on flesh-and-blood securities indexes like the S&P 500. That index was all over the place on Tuesday and Wednesday as investors placed their bets on the likelihood of a Greenland invasion, or the follow-through with another round of punishing tariffs on Europe. When, in the middle of a rambling and incoherent speech on Wednesday, the three-word chain “won’t use force” manifested, the reaction on the stock indexes was immediate, and those who had placed “no invasion” bets on Polymarket cashed in their chips. For a textbook illustration of how financial assets move in the world of today, one could do worse than to study the minutiae of Tuesday and Wednesday this week.

Lots of Events, Absence of Vision

Polymarket, Kalshi and their ilk are called “event contract” platforms, a bit of technicalese meant to distinguish them from (heaven forbid) gambling sites. They are fast becoming a central part of the mainstream financial market infrastructure. Fortunately for their executives and shareholders, there are plenty of events to wager on as this new geopolitical era dawns. Few people imagine that Trump’s speech on Wednesday marked the last time Greenland will be in the news, but never fear, there will be other “events” in the weeks ahead. And because the data around these bets (sorry, “event contracts”) tend to get instant visibility in the financial media, they have the ability to validate an imagined future outcome before the nuts and bolts behind that event have been deliberated on by those involved in and responsible for negotiations around it. We run the risk of pinballing from one crisis to the next without any kind of through-line to connect the dots. This adds a whole new dimension of risk to what observers like Adam Tooze, the Columbia professor and author of the widely-read Substack “Chartbook” call the “polycrisis,” the simultaneous presence of crises on multiple fronts, about multiple things.

This lack of vision brings back to mind those unsettled days in the Balkans in the late 1870s. The tumult seemed to die down in 1878 with the Treaty of Berlin, an ambitious attempt to keep the Ottoman Empire from completely collapsing while at the same time giving nationalists in Serbia, Bulgaria and elsewhere a bit of opportunity to express themselves but within the strictures of administration and guidance from the Great Powers. In a practical sense – though only a handful of observers realized it at the time – the Treaty of Berlin set two of these Great Powers – Tsarist Russia and the Hapsburg Empire of Austria-Hungary – implacably against each other. Germany, worried about Russia’s encouragement of pan-Slavism in the Balkans, bound itself to Austria-Hungary and then with Italy in a Triple Alliance. The bonds between Russia and France tightened at the same time and would eventually lead to the Entente Cordiale between these two countries and Great Britain.

The Concert of Europe – a global order that had managed, more or less, to keep the peace since the end of the Napoleonic Wars was thus replaced after the Treaty of Berlin by the formation of two great-power alliances that became ever more belligerent and defensive as Europe reeled from one crisis to the next, in the Balkans, in Algeria and elsewhere, before it all blew up in 1914. Such are the risks of the great power mentality that we appear to have stumbled back into. We are going to be in need of clear, strategic thinking as we move towards whatever the new world order is going to be – and we would be well advised to pay little heed to what the Polymarket “odds” that seem to accompany every news story of geopolitical import tell us.

Many things in the world changed in 2025, in some very profound ways and with very uncertain possible outcomes. Prominent among the things that didn’t change much, though, were financial markets and the global economy in general. That was something of a surprise, given the volatility we experienced during the late first and early second quarters of the year. But the volatility settled down. The direction of the economy pointed up, as did the path of risk assets. Bond yields were for the most part pliant during the second half of the year. Companies made plenty of money, and a number of them reported record sales and earnings, despite the many reasons why that plausibly might not have been the case.

Simply putting 2025 into the context of, say, the previous couple years of economic activity (both of which were likewise upward-pointing), there would seem to be no reason to think that anything had changed much in the world. American consumers continued to spend their hard-earned incomes, artificial intelligence enterprises continued to build out their sprawling empires of data centers and large language modules, and China found plenty of markets eager to import its products despite lower levels of activity with the US following the threat of higher tariffs (and imposition of some, but not all of the ones threatened). Europe muddled through yet another year of slow, but still positive, growth. In Japan, the long-reigning Liberal Democratic Party did what it does best, adapting just enough to a changing society to remain in power, helped by the emergence of a new and popular leader. Brutal wars dragged on in geopolitical hotspots, notably in Ukraine, Gaza and Sudan, but managed to avoid the catalysts that would turn a regional war into a global conflagration. At the end of it all, the S&P 500 stock index notched its third positive year in a row, up by just under 18 percent for the full year. This was the eighth positive year for the benchmark large cap index over the past decade.

Since we are now sixteen days into Year 2026 of the Common Era, it is once again time for everyone in the financial field to make bold pronouncements about the Great Rotation that is to January what the Great Pumpkin of Peanuts fame is to October (i.e., the wild imagining of an impressionable mind). It’s true that small cap and value stocks have done comparatively well in this year’s early days. And as of this morning five of the fabled “Magnificent Seven” stocks that for the past three years have served as an easy market shorthand for “AI leaders” are trailing the S&P 500. But the way we see it, this is less about the eclipse of the AI narrative, which shows no signs of going away as a core component of US economic growth, than it is about the AI story getting more complicated, with more careful parsing of where different companies actually stack up in the narrative. We’ll introduce two names in the chart below that are not part of the Mag Seven but are very much at the center of all things AI: Taiwan Semiconductor (TSMC) and Micron Technologies.

What’s In a Name

In the chart above we see outsize gains for the year so far by Micron and TSMC, up 18 percent and 12 percent respectively. Among the Mag 7 only Alphabet and Amazon are ahead of the index while Nvidia is just slightly behind and the other four (Tesla, Microsoft, Apple and Meta) trail by a wider margin. This week TSMC, which essentially manufactures all the chips that other companies design, reported another quarter of blowout earnings, growing revenue by more than 20 percent, expanding gross and operating profit margins, and raising its forward guidance by more than the consensus of sell-side analysts had expected (and they had expected a lot – the performance bar for TSMC was high). In terms of the potential impact on overall economic growth, TSMC’s capital expenditure forecast was also raised to $52-56 billion for this year alone, with more to follow. Translation: the AI infrastructure spending binge that has been the central economic story for the past three years is not slowing down. For this single reason, let alone other factors like consumer spending or net exports, we believe it remains unlikely that we will see a recession in the US this year.

One big part of that infrastructure spending binge will be on memory, in the form of DRAM chips, and that is where Micron Technologies comes into the story. Micron has been around for a very long time, and its core competency for all this time has been the comparatively dull memory segment of the chip market. It turns out, though, that the memory capabilities of Micron’s DRAM chips are essential to AI model development, and currently demand is outpacing supply. Micron is investing heavily to meet that increased demand – hence, yes, more spending that will translate into the GDP growth equation.

Tell Me Your Story

We focused on these two companies (there are others) because they reflect a general sharpening in the AI story that, we think, will lead to more dispersion among the performance of stocks in this space, rather than the simplistic “buy Mag Seven” story of yesteryear. Tesla, Apple and Meta are the names we think could be on the other end of this dispersion (though any one or all of them could perform well for other reasons – none of them are AI pure plays in any sense). As for Nvidia, which has been the big name in this space ever since ChatGPT mania took off in early 2023, it continues to maintain a solid competitive advantage in supplying the leading edge of graphic processing unit (GPU) chips to AI developers. But competition from China, while not fully formed today, will be a competitive threat the company must take into account as it charts the next phase of its strategy.

Back to the issue we raised back at the beginning of this piece, about the purported Great Rotation from the things that have done well recently to the undervalued corners of the market among value and small cap names. Will this happen, or will it fizzle out as these things often do? We don’t know, nor are we inclined to shuffle around a lot and run up big capital gains in order to find out. We are less interested in momentum-driven rotations and more interested in having a better understanding of the landscape in that part of the market situated at the center of economic growth. For now, at least, that remains the dynamic and constantly changing AI space.

Regular readers of our weekly column will know that we put very little stock in the flood of predictions made by investment houses large and small as the New Year gets under way. Who knows where the S&P 500 or the MSCI All World Index will be eleven and a half months from now? Not us, not the heads of Wall Street bulge bracket banks, not the Fed chair or the economics departments of Harvard or MIT. All manner of things are going to happen, in our country and the world at large, between now and December 31. All we can do is to say that there are some things out there that we are paying closer attention to than others. Here are five of those things, reflecting our opinions about what may have a fair chance of mattering in the year ahead. These are, of course, only our opinions.

The US economy is weaker than the numbers suggest

Perhaps the most surprising thing about the economy last year was what didn’t happen: namely, it didn’t implode. The highest tariff rates since the misguided Smoot-Hawley regime of the 1930s didn’t create runaway inflation (yet, anyway), or stop American consumers from their tried and true shopping habits. Growth surged ahead on the back of the artificial intelligence spending spree (more about that below). But “affordability” is not just a political buzzword; it is the issue that households place as number one on their list of concerns. The jobs market, meanwhile, has been weakening at a slow enough pace to keep the headline numbers well away from red-flag levels presaging recession. But that could change quickly, particularly if some of those use cases for AI show up sooner rather than later. The “soft data” survey numbers have been depressed for awhile now; we will not be surprised to see the hard data follow suit.

Fed credibility will be a bigger issue than markets are currently assuming

After the financial crisis of 2008, central banks in general and the Fed in particular became the single most indispensable part of the architecture of the global financial system. Markets await interest rate decisions with bated breath and spend much of the time in between Federal Open Market Committee meetings debating and prognosticating what will happen at the next one. So it is perhaps a little surprising that the possibility of a politically compromised Fed – an outcome with at least a reasonable probability of happening – is not showing up as a top-level concern for the market. Interest rates have been rather quiescent for much of the time in recent months. The history of political tinkering with interest rate decisions is a generally sad history, whether we are talking of the Nixon – Arthur Burns era of the early 1970s here at home or, abroad, the incessant meddling of Turkish president Recep Tayyip Erdogan in more recent memory. We will see if the calculus changes, particularly in the bond market, as Jay Powell’s term approaches its end in May, or sooner than that depending on who gets the final nod from Trump.

AI stocks may or may not take a tumble, but the infrastructure build will continue at full speed

Are AI stocks in a bubble? That was the question of the day on many mornings late last year as CNBC talking heads gathered in their virtual Brady Bunch-esque space to ponder which way markets may be heading. It is an imprecise question, obviously, as defining bubbles is as effervescent as blowing bubbles. There is certainly a distinct possibility that AI-themed stocks could pull back – into correction or bear territory, even – given their consistent outperformance over the past three years. Whatever happens to share prices, though, we expect that the frenetic pace of infrastructure building will continue. AI is the central economic story for the 2020s. We are still in the building phase, and it may be some time yet before the companies investing heavily in AI capabilities are able to clearly demonstrate proof of concept to justify the hundreds of billions of dollars invested (it also may happen sooner, in which case we may have to massively revise our assumptions about the jobs market). We think that investors will be reluctant to completely pull out of their exposure to AI names as long as the possibility remains that these innovations will lead to levels of economic productivity not seen for at least half a century. Any pullback, in other words, would be more likely than not, in our opinion, to be temporary in nature.

China will double down on manufacturing while muddling through its present woes

China’s next five-year plan, which covers the period between now and 2030, will come out in March. It should come as a surprise to nobody that the plan will be doubling down on major investments in manufacturing processes aimed at achieving global economic dominance. China demonstrated in 2025 that, apparently alone among all countries, it was able to not only withstand the threat of massive tariffs from the US, but to push back strongly and force a retreat from the Trump administration. That strength derives from its strategy, many years in the making, of building dominance in the market for rare earths metals that are key ingredients to a wide range of manufacturing processes. Having won the first round, why stop there? But as promising as China’s strategy looks for long-term success, the country continues to be somewhat flippant about the problems plaguing its present-day economy, including an eviscerated property sector, anemic household demand and the ever-present specter of deflation.

Europe will have to figure out its economic and foreign policy in a new and unfriendly world

The car industry is a good place to start when thinking about the many problems facing Europe as 2026 gets going. Time was, when Europe’s car industry was a key component of its longstanding strategy of exporting high-quality products to an eager Chinese market. Now, China manufactures and exports some of the most successful auto brands in the world, notably including electric vehicle maker BYD which surpassed Tesla last year as the globe’s largest EV maker. China is a competitor to Europe in ways that it was not just a few years ago. Meanwhile, the strength of Europe’s political alliance with the US is also a thing of the past, which has additional economic implications beyond merely the headache of higher tariffs. Patience among Europeans from Sweden to Spain is running thin. In France, Emmanuel Macron’s governing coalition is hanging on by a thread, and there is still a possibility that the coalition’s ability to stay together will run out before Macron’s official term ends in 2027. Europe does have some things to be cheery about, notably inflation that has settled back to the European Central Bank’s two percent target. And the ramping up of defense spending should help to keep growth positive this year. But time is not on the side of the rules-based EU as the rule of law fades from view elsewhere in the world.

There are no doubt many other variables at play that we have not covered here. But this is a start. Let’s get to work.

Well, here we are. 2025 is coming to an end and we have somehow made it through. Yay! There are plenty of things we could dwell on as standout themes for the year gone by, but the one that looms largest in our minds is – not for the first time and probably not for the last time – the resilience of the global economy. Let’s look at some of the ways we managed to survive the year, economically speaking, when there was so much change afoot.

Ghosts of the 1930s

Two senators of a bygone era became a big part of the economic Zeitgeist this year. Reed  Smoot of Utah and Willis Hawley of Oregon were the driving force behind the Smoot-Hawley Tariff Act of 1930, an act part and parcel of the isolationist tack American politics had taken since the early 1920s and one that poured more cold water on a world economy already freezing from the onset of the Great Depression. Since then, critics of tariffs in general have never hesitated to call on the haunting specter of Smoot-Hawley to argue for why an exorbitant tax on goods coming into the US is a bad idea.

So when the Trump administration trotted out its “Liberation Day” tariff schedule on April 2, with tariff rates that in many cases soared past the levels of Smoot-Hawley, a tidal wave of criticism ensued. Financial markets tumbled in the wake of the April 2 announcement at levels suggesting that another Great Depression was in the offing. Famously, the administration backed off (“TACO-ed” in the wry parlance of Wall Street) and held off (indefinitely, as it turned out) on those nosebleed levels. Still, though, after all was said and done, the average tariff rate on imported goods into the US remained around 17 percent – the highest since, yes, the days of Smoot-Hawley in the early 1930s.

Not Your Great-Grandfather’s Economy

And yet, there was no Depression, no recession even. In fact, the US economy has grown at a higher pace this year – so far, given that we only just got the third quarter numbers last week and won’t have Q4 data until later in January – than at any time in the post-pandemic period. Inflation, which was supposed to skyrocket, has been relatively subdued even if still stubbornly stuck above the Fed’s two percent target. Unemployment has been trending up, but remains far away from the levels usually associated with a sharp economic reversal. Outside the US, countries that were on the receiving end of the tariff shock have mostly kept on keeping on – notably China, which has successfully managed to find other markets to offset the slowdown in its level of exports to the US.

What is important to bear in mind here is that the economy of 2025 bears very little resemblance to the one of the 1930s. For one thing, it is an economy far more dominated by a wide variety of services than was the case 95 years ago. Tariffs did, clearly, have a major impact on certain categories of goods, notably raw materials like steel and foodstuffs like coffee, among many others. But their impact on many domestic services was more muted. Price changes were thus varied and reflected many more driving forces than tariffs alone, such as a greater level of consumer pickiness in making discretionary spending choices (recall our comments last week about the so-called “K-shaped” economy).

Another way today’s economy differs from that of our great-grandparents is the outsize role played by investment in technology. Today, of course, the main event in this space is the multi-billion dollar race for dominance in artificial intelligence, the fruits of which probably accounted for around half of the total growth rate of real GDP this year. It remains unclear how much of this massive investment spree will translate into measurable productivity gains – but that is a question for another day.

Globalization and Global Order

We will leave this discussion with a couple notes on a topic you will be hearing a great deal about from us next year. One of the popular sentiments expressed in the financial media in recent years has been the so-called end of globalization. This formulation mixes up a very broad term with a more narrowly defined one. What has ended is not globalization, which simply refers to the act of seeking and utilizing sources of wealth outside one’s home market. Globalization has been going on since the fifteenth century, and will continue going on indefinitely.

What ended – and really, what ended many years ago – was the cultural dominance of neoliberalism. Neoliberalism is the narrower term we noted above. It refers to a belief in free trade, open borders and minimal interference from government-backed regulation as the best prescription for global growth. While there were always plenty of naysayers and critics, neoliberalism dominated economic thought and practice from the early 1980s to the late 2010s – a period we refer to as the Global Age. And even at its peak, in the heady years following the end of the Cold War in 1991, the nuts-and-bolts components of neoliberalism were more of an aspiration than a real description of how countries in the real world traded and dealt with each other.

More importantly to us today, the Global Age was the second act of a global order that began after the Second World War, an order entirely dependent on the active leadership of the United States and a strong alliance among the nations of the West (a term less useful as a geographic descriptor than as an alliance of shared values and democratic commitments). When the Global Age ended, not long after the 2008 global financial crisis, the Pax Americana global order started to weaken as well. We are of the opinion that we finally lost it, likely for good, this year. What will emerge as the new global order is very much unknown as we head into 2026. The good news, though, is that we begin the new year with a global economy still resilient, still adaptable, and still able to somehow steer through the fog.

More to come on all of this in the year ahead. May the New Year be a happy, healthy and prosperous one for you and yours.

Sometime earlier this year we wrote about the disconnect between so-called “hard” and “soft” economic data. Hard data points include the headline numbers of inflation, unemployment and GDP growth, while the concept of soft data refers to surveys about how different cohorts in the economy – households, small businesses and the like – feel about the current situation and their near-term prospects. When we wrote about this during the first quarter of 2025, the disconnect was reflected as negative sentiments expressed in the “soft” surveys while the “hard” macro numbers seemed to validate an economy that was still performing relatively well.

Gross Domestic Skepticism

Well, that disconnect trend is alive and well as 2025 draws to a close. This morning we received the report on gross domestic product for the third quarter, after a two-month delay during which the Bureau of Economic Analysis, which produces the GDP report, was offline as a result of the government shutdown (the economic effects of said shutdown may show up in some form when the Q4 report comes out next month). For anyone hoping for a good growth story to see out the year, this report delivered it. The economy grew in real (inflation-adjusted) terms by 4.3 percent (annualized) from the beginning of July to the end of September. Consumer spending continued to surpass economists’ expectations, defying the widely-held concerns earlier this year of a consumer pullback. Meanwhile, investment in the building blocks of artificial intelligence continued apace, and somehow we also managed to export more than we imported during the quarter (a positive balance for net exports is additive to GDP). Economists did caution that the slowdown that didn’t happen in Q3 may be on tap for Q4 – but that’s a problem for another day, right? Meanwhile, the US economy’s often surprising resilience remains intact.

A little while after the GDP report came out, though, we got another wet blanket of a sentiment indicator. The Consumer Confidence Index, published by the Conference Board, weakened for a fifth consecutive month and remains well below its peak at the beginning of the year. One of the major areas flagged as a concern is the job market, with fewer respondents saying that job opportunities are plentiful, and more characterizing jobs as “hard to get.” The news wasn’t all bad – there was a slight drop in the percentage of respondents saying that a recession in 2026 was “very likely” – but for the first time in more than three years, the percentage of people saying their current family situation is bad was greater than the number saying that things are good.

Brought to You by the Letter K

If you have been reading articles about the economy recently, chances are that you have come across the concept of the “K-shaped” economy, with the upper slant of the K representing the increasing prosperity of wealthy Americans while the lower slant signifies the mounting struggles of their worse-off counterparts to keep up with higher prices, stagnant wages and fewer opportunities for moving up (or getting into the labor market at all, if you are a young job-seeker coming right out of college and wondering what on earth happened to those jobs you thought would be there as you grabbed your BS degree in computer science). Much of that resilience in consumer spending this year we noted earlier has come thanks to the fortunes of the upper deciles of income-earners, while establishments that cater more to those in the middle or lower end of the scale, such as McDonalds or Walmart, have supplied evidence of greater constraints experienced by their clientele. This dispersion of conditions explains at least some of the disconnect between hard and soft data. Reports like the Consumer Confidence Index contain a mix across all income and demographic categories, so dissatisfaction with the present state of play is likely to come through when all the responses are tallied up – eight deciles of “not so great” versus two of “doing just fine, thanks for asking.”

Can the fortunes of a K-shaped economy get us through another twelve months? As we pore through the various musings of our peers in the economics world, the overall sense seems to be that 2026 will be a pretty good year. Not great, but not terrible. We’ll see. Sentiment can shift on a dime, and right now the sentiment seems mostly influenced by how much better 2025 turned out than many imagined back in the first few months of the year. We are pretty confident that there will be unexpected hits to the collective, conventional wisdom from all sides.

For those who celebrate, have a very Merry Christmas.

The latest Global Fund Manager Survey published by the Bank of America is out. The survey canvasses the opinions from 238 institutional fund managers, collectively managing around $364 billion, on a wide spectrum of issues around the economy and financial markets. The tenor is pretty upbeat. Well, very upbeat, actually. The sentiment indicator – a broad measure of expectations about economic growth and equity market performance – is the highest it has been since July 2021.

What to Expect When the Market Expects Bulls

That sounds nice, perhaps. Fund managers (for reasons we do not entirely share) are happy with the economic direction of things. They have high risk appetite. Cash levels among these fund managers, at 3.3 percent, is the lowest on record since BoA started keeping tabs on these things in 1999. Defenses are lowered, in other words. Meanwhile another metric in the BoA report, called with a full dose of clarity the “Bull & Bear Indicator,” currently reads 7.9. This indicator has a couple key threshold levels. One is 2.0, which investors interpret as a buy signal because it suggests that the fund managers are overly bearish. The other is 8.0, which is interpreted as a sell signal because it points to too much optimism among the fund manager set – an outpouring of animal spirits reflecting what former Fed chair Alan Greenspan called “irrational exuberance” back in 1996.

Of course, just because a number like the Bull & Bear indicator warns of too much optimism does not mean that a course correction is just around the corner. Anyone who took Greenspan’s comments seriously and sold out of the US equity market in 1996 missed out on some of the best years stocks in this country have ever experienced. What it does say, though – and this should not be a surprise to anyone who has been following the path of the market over the past few months – is that markets are closer to being priced for perfection than being tethered to historically reasonable valuation ranges. That means that any number of things could happen in the global economy next year to take the wind out of the market’s sails. Here is where we come back to the comment we made above: we see plenty of reasons to question whether the 2026 economic growth story is quite as robust as the fund managers seem to think.

The Mixed Bag Economy

To be clear, the base case we have been building for next year does not contemplate a recession at least for the foreseeable future. It has been a while since we have seen GDP growth numbers – thanks to the government shutdown, we won’t get the Q3 reading until next Tuesday. But the consensus estimate among economists is around three percent, and that comes on the heels of the 3.8 percent growth recorded in Q2. A big part of the growth story involves the hundreds of billions of dollars pouring into AI infrastructure, and that trend shows no signs of slowing down, even as some observers question how much of that capex is going to produce a real return on investment. On the consumer spending side, the slowdown we have been watching all year has not turned into a freeze.

We expect growth will slow next year. What might make outcomes differ from a modest slow-growth base case, though, are negative developments in the labor market and consumer prices. Today we finally got a look at the November jobs numbers from the Bureau of Labor Statistics, and they presented a mixed bag. Nonfarm payrolls rose by 64,000, which was more than the 40,000 consensus estimate (the NFP number for October, which also came out today, showed job losses amounting to 105,000 but that was almost entirely due to the one-off factor of federal employees accepting deferred resignation). But the overall unemployment number rose to 4.6 percent, the highest since September 2021 in the aftermath of the Covid pandemic. Unemployment has risen steadily all year, while companies that track layoffs such as Challenger, Gray and Christmas have reported multi-year high levels of layoffs in recent months. In his remarks last week following the Federal Open Market Committee’s monetary policy meeting, Fed chair Jay Powell noted that risks to both unemployment and consumer prices are skewed to the upside, meaning more potential to get worse than to get better. We concur. The best way we think we can describe the economy now is as a mixed bag, open to interpretation.

So we see the potential (though in no way inevitable) for a bumpy ride – and that is to say nothing of the concerns about the bond market which we shared with you a couple weeks ago. You will see a deeper set of our thoughts about the economy in a few weeks when we publish our annual outlook. In the meantime, let’s enjoy the fund managers’ upbeat vibes while they are still around.

It has been something of a rite of passage in recent years. As the year gets underway in January, the financial chattering class lands on the age-old question. Is this Europe’s year? Is it time for portfolio managers to shift weights out of the US and into assets on the other side of the Atlantic? Typically, this festival of talking heads will take place immediately after a day in which the MSCI Europe Index or a similar benchmark ends up ahead of the S&P 500. In recent years, though, it has always ended the same way. Whether the out-of-US rotation was for one day or one month, US stocks always found their way back. Over the past ten years, the performance gap between US and non-US stocks has been immense. During this time the S&P 500 delivered a cumulative total return of around 308 percent, while the MSCI EAFE Index (an index of developed economies in Europe, Australia and the Far East) returned a cumulative 131 percent over the same period.

This year has been different. European bourses started 2025 on a strong note, and they are finishing strong. The chart below shows the relative performance of a handful of national European indexes, as well as the more broad-based EAFE index, versus the S&P 500 for the past 12 months. The returns are shown in US dollar terms, the relevant number for a US-based investor.

The Midyear Correction That Wasn’t

The sustained outperformance of European equities caught a number of market observers by surprise, particularly after US markets settled down in the weeks following the ill-considered “Liberation Day” tariff plan unveiled in early April. Once investors figured out that the White House was going to back away from completely scuttling the global economy, US stocks rallied sharply. In particular, the AI-themed growth darlings of the past three years, which endured a rough patch in the first couple months of the year, bounced back with their customary brio. AI infrastructure dollars kept pouring into the economy, raising growth expectations and (for the time being, anyway) putting paid to the earlier fears of an economy brought low by rising tariffs and fading consumer spending. Surely, investors thought, the moribund economies of Western Europe would once again pale in the background while US tech dynamism surged back onto center stage. That brief moment in the sun for European equities would end the way it always ends, with second-half doldrums leading once again to a second-place finish. But no, not this time. Throughout the second half of the year the relative performance numbers waxed and waned, but Europe and non-US equities generally held their ground and then some. Barring some entirely unexpected development between now and December 31, European equities will see out the year with a healthy record of outperformance.

Currencies and Other Matters

Investing in foreign assets, of course, exposes an investor to more than the underlying cash flows of the assets; it also exposes her to the currencies in which the assets are domiciled. Currently, the euro is up around 13 percent versus the dollar for the year to date. Let’s think about that in terms of our US-based equity investor with a position in European equities. That 13 percent currency differential translates to an immediate gain: even if the European equity position ends the year completely flat in local currency terms, our investor’s year-end statement records a 13 percent positive return.

But there has been more to the story than just the fact that 2025 was a relatively bad year for the US dollar. Currently, the total return for the MSCI Eurozone Index, which tracks the performance of stocks in the single currency region, is up around 39 percent versus 19 percent for the S&P 500 – a differential of around 20 percent. We can attribute 13-ish percent of that to the currency factor, leaving around seven percent of pure equity vs. equity outperformance. The question a reasonable investor wants to know is – why? And is that differential sustainable?

If by “sustainable” you mean “likely to outperform again in 2026” – well, who knows? The short term is unknowable. But if “sustainable” means a structural, medium to long term case for more diversification out of US dollar-denominated assets, then we would say yes. The world is a very different place today from what it was just several years ago. What that means specifically for Europe – or for China, or Japan, or for frontier markets in Africa, for that matter – remains to be seen. But having more geographic dispersion in one’s portfolio than may have been necessary in the recent past is, we think, an appropriate goal when looking beyond whatever happens in the next twelve months.

Happy December! It’s the last month of 2025, which has been a strange year in oh so many ways. It is also the month when, by custom and tradition, our leading financial institutions tell us, in very specific terms, how the S&P 500 and the Nasdaq and the Dow will all fare in 2026. Please. You will have just as much insight into what the US stock market will look like twelve months hence if you ask the question of your friendly neighborhood psychic. Or your dog, for that matter.

Rather than trying to pin a number on something that is entirely unknowable, let us instead think about what some of the wild cards might be that buffet assets hither and yon next year. One that we have been paying attention to recently is the Japanese bond market. It was not too long ago – little more than a year in fact – when the most notable feature of this market was negative yields. Under the hyper-stimulatory policies of the Bank of Japan, investors in Japanese government bonds (JGBs) not only received no interest income, but those interest payments actually went in the other direction

Takaichi-nomics

Those days are gone. The 10-year Japanese government bond yield has nearly doubled since the beginning of the year, with much of the growth spurt coming in the past two months as the new government led by prime minister Sanae Takaichi came into office with big plans for some major fiscal stimulus to shake Japan’s economy out of its recent lethargy. At the same time the Japanese yen, which had risen sharply against the US dollar earlier in the year, has plunged by around seven percent against the greenback.

The Bank of Japan has already raised rates three times since March 2024, at which time the benchmark policy rate was still negative. The BoJ meets again next Thursday (one day after the Fed holds its December meeting), and analysts are now expecting that this meeting will produce another rate hike. BoJ Governor Kazuo Ueda suggested as much in public comments earlier this week, and swaps markets are now pricing in around a 70 percent probability of another hike.

The policy action stems from concerns that the new Takaichi government will be tapping the debt market for sizable supplemental issuances next year in order to fund a massive budgetary program to promote economic growth. Investors have grown wary of longer-dated bonds recently, with a collective holding of breath and then a measure of relief when a 20-year JGB auction this week managed to scrape out enough demand to cover the issue. Observers worry that the government’s plans will prove too ambitious for the market to swallow, particularly if the size of the government’s budget necessitates going back to those shaky longer maturities. The same concerns have been behind the recent pronounced weakness in the yen against other major currencies.

Carry That Weight

The other major implication for bond markets outside Japan is the way higher yields upend the carry trade, a long-standing and arguably stabilizing factor in global credit markets. In a world of ultra-cheap Japanese yields, investors borrowed in yen and invested in higher-yielding opportunities elsewhere. Japanese financial institutions are among the world’s largest creditors, and in recent years Japan surpassed China as the largest international holder of US Treasuries. But the prospect of higher rates in their home country may drive the Japanese financial institutions to repatriate a meaningful part of their overseas holdings, which in turn could drive rates higher elsewhere. Including, yes, the US Treasury market. And equity markets, as we all know, are downstream from and highly affected by changes in fixed income yields.

This could be one catalyst for a very messy year in global credit. There are plenty of other reasons to not be looking forward to bond markets next year. Here at home, latter-day bond vigilantes have been trying to steer the White House away from turning the Fed into a supplicant to the president’s monomaniacal desire for ultra-low interest rates. Dissension among Federal Open Market Committee members has been a factor of the past several FOMC meetings, a trend which could turn even sharper in the months to come.

But even in the event that the administration were to get its way and start pushing the Fed funds rate ever lower, the forces affecting longer-term rates – i.e., the ones that have more impact on real-world economic activity – are much less easy for politicians to control. Such as, for example, a sizable exit by Japanese banks from their US Treasury holdings in response to the higher yields back home. This may not come to pass, of course. But it will require close attention in the weeks and months ahead.

And then there were two. Oh how ye have fallen, mighty Magnificent Seven of yore. Today, just two of these august mega-cap companies, so crucial to the long-running saga of AI dominance over the US stock market, are outpacing the S&P 500 in price gains for the year. The fortunate two are Nvidia and, now in the group’s pole position, Alphabet. And herein lies a lesson about how the AI story, through all its strange twists and turns over the past three years, keeps coming out ahead.

The Deep Seek Effect, Reborn

Earlier this year, the AI world was shaken by the sudden appearance of Deep Seek, an offering from China that appeared to do just about everything its US competitors could, only at a much cheaper price. What if, the pundits asked, all those hundreds of billions of dollars being poured into AI infrastructure projects here at home turned out to be wildly overdone? For a couple weeks, the Mag Seven and others in their orbit took a big hit. Then, as tends to be the case, investors did a rethink and decided that there was plenty of room for both the Deep Seeks of the world and the cascade of dollars building out data centers and large language models and all the rest of it on our shores.

This week, the financial chattering class has been all abuzz about what is being called “another Deep Seek moment.” Deep Seek is apparently the AI equivalent of Watergate – the iconic event whose name one attaches to every subsequent development of major note in the space, be that leaps forward in AI technology or political scandals. In any case, this week’s Deep Seek moment is called Gemini 3, the newest addition to the world’s stable of AI large language modules (LLMs), this one courtesy of Alphabet, the parent company of Google. Gemini 3, according to experts familiar with the milestones by which LLMs are evaluated, has demonstrated superior capabilities to OpenAI’s ChatGPT, up to now the US poster child for the wonders of generative AI.

TPUs Ratchet Up the Tensors

Gemini 3 is powered by internally developed (at Alphabet) chips called Tensor Processing Units (TPUs), which are different from the Graphic Processing Units (GPUs) dominated in the AI space by Nvidia. Hence, in the chart above, the stark contrast between the recent share price trends of Alphabet (way up) and Nvidia (way down). TPUs appear to be a cheaper alternative to Nvidia’s GPUs (here again the “cheaper alternative” refrain from Deep Seek), and Alphabet has been approaching other LLM developers, such as Anthropic, in what could be a direct threat to a portion of Nvidia’s revenues (Alphabet itself is also a customer of Nvidia, illustrating the tangled web of customers, partners, investors, friends and enemies in this industry).

Time For Another Rethink?

The story, of course, is never that simple and is likely to evolve and shape-shift yet again. Alphabet’s TPUs were developed largely with that company’s products in mind, and there are probably serious limits to how fungible they will turn out to be in adapting to the products of other AI service providers. Nvidia’s chips have an edge here in that its software platform is designed for a broader spectrum of applications. Recent comments from spokespersons at Nvidia suggest a lack of undue concern over there, whether due to confidence in their chips being one or two generations ahead of the pack or simply a show of bravado. One way or another, though, there are likely to be many more chapters to the AI story, and plenty of “Deep Seek moments” in store for the months ahead.

Meanwhile, it is time to take a short break from all things global markets and enjoy the company of our friends and loved ones as we gather for Thanksgiving. May yours be full of good cheer and good health.