View From The Top: When bulls clash with cockroaches

View from the very top: the wall of worry continues to be climbed. Ignore sources of potential downside and carry on regardless seems to be the prevailing mantra. The positive case revolves around the alluring cocktail of robust GDP growth, dovish Central Banks and accelerating corporate earnings. However, it does not take a huge conceptual leap of faith to reframe the debate with the concerning trifecta of elevated valuations, high debt-to-GDP ratios and a massive private credit market with unknown liabilities. Timing, of course, is the problem. Bubbles normally burst for unexpected reasons and negative narratives have not stuck all year. History might suggest that it is better to ride bull markets rather than try and time them. Our counsel is to keep on actively diversifying into a broad range of uncorrelated assets. Stay nimble and remain pragmatic.

Asset Allocation:

Equities: Markets globally are continuing to make new highs. Encouragingly, this is being driven by earnings growth rather than rising valuation multiples. Market breadth is also improving, which should be positive for stock pickers that have been challenged by increasingly concentrated indices. We have been wary for some time of being over-exposed to a US market driven by a limited number of stocks. Our preference has been to diversify by region and style (Japan and EM look interesting) and focus on more neglected sectors such as healthcare and consumer staples.

Fixed income/ Credit: Almost 90% of all public fixed income in the world currently trades on a yield of less than 5% (according to Bloomberg). With inflation running at c3%, this implies a real return of 2% or less, which we regard as generally unattractive. The decline in credit spreads between government and high yield debt suggests that there is little reward available for taking extra risk at present. Government bond yields could therefore compress further. Risks in private credit appear to be growing and require careful monitoring.

Currencies: We have not been surprised to see the US Dollar strengthening over the past month. Mean reversion is only normal in respect of currencies, especially after the biggest loss in over 50 years in the first half of 2025 for the US Dollar Index. The prospect of potential easier monetary policy going forward may drive relative Dollar strength.

Gold: Even with October’s pullback in the price of gold, the precious metal is on track to record its best year of performance since 1979. We continue to see gold as a core allocation within portfolios. 95% of Central Banks report that they intend to increase their holdings in gold (per Bloomberg). It also serves as a hedge against political dysfunction, the weaponisation of currencies and potential financial repression.

Alternative assets: Allocations to this asset class can increasingly serve as a form of replacement for fixed income, offering both portfolio diversification and income-generating characteristics. Hard assets should also exhibit resilience in the face of macro volatility and political ambiguity. We favour selective investments, particularly in uncorrelated strategies.

What happens when a stampede of bulls meets an intrusion of cockroaches? Plaudits to JP Morgan’s Jamie Dimon for recently raising the profile of the latter humble species. We may be about to find out soon. Despite the extensive rally in many risk assets, things do feel precarious. There is more than a whiff of FOMO in the air ahead of year-end. Fund Managers’ cash levels are the lowest they’ve been in a decade (according to Bank of America). Asset allocators perhaps are feeling the pressure to remain fully invested. The mantra seems one of ignoring sources of potential downside and carrying on regardless. Markets, of course, have demonstrated a remarkable ability to climb a wall of worry.

Bulls will naturally point to how the prospect of further rate cuts combined with upwards revisions to earnings estimates makes for a potent combination. Equity markets can hence continue to rise. A further thawing in US-Chinese trade relations would act as an additional boost. With GDP growth robust, liquidity plentiful and capital raising easy, there is little not to like. And despite all the above, some $7.5tr remains in money market funds (per Bloomberg) waiting to be deployed.

It is hard to ignore the strength of corporate America, at least based on current quarterly reports from S&P 500 Index members. The ratio of earnings beats relative to consensus expectations is the highest in four years, with revenues outpacing expectations at double their historic average. The US market is set to enjoy around 10% earnings growth this year, accelerating to over 12% in 2026, according to Bloomberg.

With corporate earnings running this high (growth metrics are similar for global indices), it is almost unheard of for the economy to run into recession. Higher stock prices are certainly helping to create a wealth effect that is supporting consumer spending. The IMF recently raised its estimates for global GDP growth relative to forecasts made three months prior. With global composite industrial output data at a 14-month high (according to a JP Morgan composite PMI Index), this should hardly be surprising. The Atlanta Fed believes the US economy to be growing at close to a 4% annualised rate currently.

The US may be in the early stages of an industrial renaissance. Corporate balance sheets remain in good health. The Big Beautiful Bill Act will deliver an additional stimulus to growth next year, contributing up to 0.4 percentage points to GDP and reversing this year’s fiscal drag (according to Alpine Macro). Encouragingly, despite robust growth, inflation remains under control. Expectations one year out are at the lowest they have been since Liberation Day in the US and recently released data show that disinflationary trends are accelerating in housing rents, one of the largest components of CPI. More AI deployments should aid productivity and may spur further disinflation.

Against this background, the thirst for risk on the part of (retail) investors seems almost impossible to quench. Indices have defied virtually every warning year-to-date and short sellers have been caught in a squeeze. The line between confidence and complacency is a fine one, but consider the ongoing ascent of leveraged ETFs, unprofitable tech and meme stocks. That SPACs are back could be considered as another sign of market excess.

However, there are no shortage of voices sounding alarm. Consider them siren calls. The IMF has warned of how “valuation models show risk asset prices well above fundamentals.” In its view, this could result in “disorderly” corrections. Moody’s notes how “aggressive growth and competition could weaken bank underwriting standards and elevate credit risk.” Jamie Dimon, JP Morgan’s Chief Executive has spoken of how “we have a lot of assets out there which are looking like bubble territory.”

It does not take a huge conceptual leap of faith to reframe the debate as follows. Forget the alluring cocktail of robust GDP, dovish Central Banks and accelerating corporate earnings growth, and replace it with a concerning trifecta of elevated valuations, high debt-to-GDP ratios and a massive private credit market with unknown liabilities. The latter two elements make this current cycle very different to the dotcom boom and bust. Jamie Dimon may be right in noting that “when you see one cockroach, there are probably more.”

Late cycle accidents do, of course, happen but they may be symptomatic of bigger problems. The collapse of First Brands could be seen as a sign of things to come. Equally, Tricolor may not be emblematic of private credit, but it has served to spotlight the risks in asset-backed lending. The overall leveraged loans market in the US might be worth as much as $2tr according to Bloomberg. It would seem only reasonable to be more circumspect over credit fundamentals. Liquidity stresses are intensifying as evidenced by how the Fed’s Standing Repo Facility (a tool that provides a liquidity backstop by offering overnight cash loans to eligible financial institutions in exchange for collateral like US Treasuries) is seeing record usage.

AI may represent another source for potential disappointment. While its impact on the real economy is not yet evident, the cash burn is clear. Record amounts of capital are being sunk into the ground. Circular deal-making and speculative infrastructure spend mask concerns about monetisation from the technology. While the hyperscalers still have sterling balance sheets, there is a risk of over-investment. It is hard to ignore diminishing free cashflows and the emergence of debt financing (per Meta’s most recent deal). Clearly if timelines for AI returns slip, then valuations could quickly compress, particularly for less financially sound (and loss-making) firms. Fund managers polled by Bank of America rate AI as the biggest current tail risk.

There are other worries too. It would be naïve to assume that we are fully out of the woods on trade. While the default has been towards compromise, each deal only buys time for the next, bigger battle. Both the United States and China want to rid themselves of current mutual dependence. This is part of the new mercantilism dynamic we have discussed previously. Fiscal dominance is here to stay. With US national debt at $37tr or 125% of GDP, at some stage there will be a reckoning. 23 cents in every Dollar is spent by the US Government on interest payments. OECD countries are spending on average 50% more on debt servicing than they are on defence. At some stage, there may have to be a necessary reckoning.

It is always uncomfortable calling the top, but all bubbles do eventually burst. What generally causes the collapse is the unexpected. Bubbles are notoriously hard to diagnose. Negative narratives have not stuck this year. What we do know is that when the bursting does come it will be painful, hence our continued case for diversification by region and asset class.

To the extent that history represents a reasonable gauge, it is often better to ride bull markets than to try and time them. Using the S&P 500 Index as a proxy and taking Bloomberg data since 1945, the average bull market has endured for 5.5 years (and the median bull for 5 years). Over this period, the Index has typically returned 192% (or 114% on a median basis). This time around, the bull market is just three years old – having begun in October 2022 – with the S&P 500 Index up c90%.

It is, of course, inevitable that there will be corrections along the way. Investors should prepare themselves for them. They would help remove some of the market’s froth. However, buying the dip has worked as a strategy this year. Stay nimble and remain pragmatic.

Alexander Gunz, Fund Manager