Europe is in a geopolitical sweet spot. Exaggerated fears of Russian military aggression and abandonment by the United States, as well as increased competition from China, created a geopolitical urgency to stimulate, reflate, and reform. Signs suggest that Europe is unifying and making serious investments in its future, led by Germany. A political and economic consolidation cycle is underway in Europe. This suggests that European risk assets can continue to outperform U.S. risk assets on a cyclical investment horizon.
Increased defense spending and the strategic shift to “buying more European” will continue to support the domestic industry. Europe’s energy crisis has proven to be far less problematic than initially feared. Now that the dust has settled, Europe is poised to benefit from historically low energy prices, driven by oversupply in liquefied natural gas.
The European Union has made slow progress on its reform agenda in 2025, including on competitiveness. Expect a shift into second gear in response to fears of U.S. abandonment and China’s threat to the European industrial sector, now that European leaders are showing greater cohesion and Europe does not face a major trade shock.
Contrary to common belief, immigration could prove to be a tailwind for Europe. While the media is focused on the North African refugee immigrants, Latin American migration via Spain and Ukrainian migration via Poland and Germany are clearly boosting economic growth in these countries and benefiting Europe as a whole.
The region’s rerating, alongside a stronger EUR/USD and a lower equity risk premia, suggests that European equities can continue to outperform their U.S. peers on a cyclical time horizon. We expect structural reforms to shift into higher gear. For nearly two decades, progress has been slow and uneven, despite widespread agreement on what is needed to address the structural issues hindering the EU.
In recent years, we have witnessed a significant shift within the EU, marked by several milestones. In 2020, the EU relied on joint bond issuance for the first time to support the economic recovery from the COVID-19 pandemic, providing the €800 billion NextGenerationEU package. Two years later, the EU responded to the invasion of Ukraine and the subsequent energy crisis by creating the European Defense Fund and launching the REPowerEU initiative to reduce European dependence on Russian energy.
Since then, two additional threats have emerged: Trump’s threat to abandon Europe and NATO and Chinese industrial competition, which, along with the fear of military aggression, created the current geopolitical sweet spot, as Europe is finally waking up.
Thanks to this geopolitical imperative, the emphasis is now shifting toward building scale, resilience, and strategic capacity, and improving Europe’s competitiveness. More than ever, the EU is pushing to complete the Single Market and deepen European integration. One clear manifestation of this shift is competition policy. The European Commission is increasingly willing to tolerate consolidation in strategic sectors, moving closer to a U.S.-style model that prioritizes scale and global competitiveness over domestic consumer interests. The focus is shifting from preserving competition at all costs to enabling European champions capable of competing with U.S. and Chinese peers. This should start a new wave of mergers and acquisitions.
A stronger EUR/USD means that the currency return enhances the performance of European stocks held by USD investors. The outlook for European equities is becoming more appealing relative to U.S. equities, even as U.S. equities trade at a large valuation premium.
That is why we continue to favor international diversification in equity portfolios. This does not mean that the U.S. stock market cannot continue to rise, we actually think it will. But other equity markets are likely to outperform the U.S., as they did in 2025.
- The Global Economy is Improving
- Unleashing U.S. Housing Market Wealth
- Time for a New Fed Chairman
- An Uneventful Fed Meeting
- Why is the Yen So Weak?
- China Needs to Stimulate Consumption
- Gold and Silver
- Our Portfolio Positioning
The Global Economy is Improving
The global economy slowed through 2025 due to tariffs and policy uncertainty, but there are now signs of a manufacturing recovery. After several months of slowing, this suggests U.S. growth may have bottomed, opening the door to improving growth momentum. Markets are driven by the acceleration or deceleration of growth, rather than its absolute level, as they respond to marginal changes rather than well-known trends. Macro momentum is thus a leading driver of relative performance between equities and bonds. Our preferred measure, the six-month change in the ISM Manufacturing index, has turned positive with the December rebound.
Historically, positive momentum has coincided with equity outperformance versus bonds, while negative momentum has been associated with equity underperformance. A single report, particularly one with clear caveats, is not sufficient to change our outlook. We are therefore watching for additional confirmation that momentum is turning. A turn in momentum would support a more positive stance on equities through stronger earnings. That is why we remain positive on global equities for the foreseeable future despite recent market volatility.
Unleashing U.S. Housing Market Wealth
American households are historically unlevered. Since the Global Financial Crisis, American households have significantly deleveraged. At the moment, households collectively hold circa $15 trillion of home equity (home values minus mortgage debt). That is an extraordinary amount of wealth ready to be unleashed on the U.S. economy at some point.
The fact that American households are sitting on lots of home equity has not been lost on the Trump administration. The administration’s plan is to use the housing market to re-lever households and, in effect, replace the fiscal gravy train and AI-capex-fueled growth with re-leveraged household wealth to increase spending. President Trump’s already announced a $200 billion purchase of mortgage-backed securities by the GSEs as a first step.
Housing is clearly a political point, one that has been identified by both the American Left and the Right as a source of societal angst. In 2024, Senator Elizabeth Warren demanded that Jay Powell cut interest rates to improve housing affordability. Is she going to oppose now that President Trump demands the same?
The new Mayor of New York, Zohran Mamdani, a self-proclaimed socialist, centered his campaign on this issue and found common ground with the president during their White House meeting. The point is that the political consensus is very strong on this issue.
What does all of this mean for markets? It will be very difficult to expect a recession amid a shift from a cash-driven economy to a leverage-driven one. Even if the AI capex slows down, which it will and is in the process of doing, a recovery in housing activity will extend the current cycle, potentially for years. This would be positive for the U.S. economy, but also for commodities, for example.
The Trump administration is now effectively focused on bringing mortgage rates lower. We have no doubt that they will do whatever it takes to make this happen.
Time for a New Fed Chairman
President Trump announced his intention to nominate former Fed Governor Kevin Warsh as the next Fed Chair. Despite concerns about Fed independence during the process, Warsh is a conventional candidate. The USD rose, and gold fell on the announcement. Treasury yields nevertheless moved higher, reflecting Warsh’s long-standing reputation for hawkish positions during and after his time at the Fed.
While he has adopted a dovish tone during the nomination process, we expect him to revert to his earlier instincts. Even when advocating for lower rates, Warsh has sought to compensate by tightening financial conditions through balance-sheet reduction. Yet, whether Warsh is a perma-hawk matters less than it appears, as institutions shape their leaders. Hawkish rhetoric is often corrected quickly by markets, and while Governors can afford to sound more hawkish, the Fed Chair is ultimately accountable for the dual mandate. Whatever Warsh’s personal views, his influence as Fed Chair will depend on his ability to build consensus within the FOMC. And whether he has committed to President Trump to become more dovish and favor cutting interest rates.
An Uneventful Fed Meeting
The Fed held rates at 3.50-3.75% in its January meeting following three consecutive rate cuts. It signalled no urgency to cut again, with only Governors Miran and Waller dissenting in favor of a 25 bp cut. Statement revisions were minimal, upgrading activity to a “solid” pace from “moderate” and acknowledging a stabilization in the unemployment rate.
Overall, the FOMC now sees reduced risks on both sides of its dual mandate after having focused on labor weakness as the unemployment rate rose last year. With recent economic data stabilizing, the committee appears comfortable shifting back to a wait-and-see stance. Political pressures and succession issues were raised during the press conference, but Chair Powell kept the focus on the policy decision. He struck an upbeat tone on growth and described the current policy stance as roughly appropriate and not significantly restrictive. While offering little forward guidance and reiterating data dependence, Powell noted that renewed labor market deterioration would warrant further cuts if inflation does not rise. We expect the Fed to cut interest rates further this year, supporting the U.S. economy and housing market.
Why is the Yen So Weak?
The conventional wisdom attributes the fall in the yen and the rise in long-term Japanese Government Bond (JGB) yields to growing fiscal concerns. This narrative, however, fails to explain why the Japanese stock market has risen by 29% in dollar terms since the start of 2025, outperforming the MSCI All Country World Index by 6%.
The main reason the yen has fallen and JGB yields have risen has to do with why the debt-to-GDP ratio has decreased. It is not because the government undertook any meaningful fiscal austerity. Rather, it is because nominal GDP growth has surged from roughly zero in 2022 to around 4% today.
Japan has finally broken out of its three-decade deflationary quagmire and the higher inflation expectations have put downward pressure on real yields, especially at the short end of the curve. As a result, real rate differentials have fallen. In 2021, 2-year real rates were 220 bps higher in Japan than in the U.S.; today, they are 145 bps lower. The 5-year real rate differential has swung from +151 bps to -181 bps. Similar swings occurred against the euro area. Given what has happened to real rate differentials, it is not surprising that the yen has weakened this much.
Where do things go from here? The yen has weakened over the past 12 months even though rate differentials have started shifting in the currency’s favor.
Some of the yen’s decline can be attributed to Prime Minister Takaichi’s embrace of Abenomics. She has pledged to suspend the food tax for two years, a measure that would raise the annual fiscal deficit by ¥5 trillion (0.8% of GDP).
However, inflation has become the top concern among Japanese voters. This reduces the incentive for any Japanese politician to push for policies that result in higher prices and a falling yen.
The Bank of Japan (BoJ) is likely to pick up the pace of rate hikes. The BoJ raised its growth and inflation forecasts at its January meeting, setting the stage for two-to-three more hikes this year. With other central banks either on pause or cutting rates, rate differentials should move in the yen’s favor.
Currently, the yen trades at a 38% discount to its Purchasing Power Parity (PPP) exchange rate versus the U.S. dollar. Against the euro, it trades at a discount of 35%. This will turn around at some point.
China Needs to Stimulate Consumption
China remains a stubborn laggard dragged down by deflation. Domestic stress is at an elevated level in China, but things may need to get worse before Beijing reacts. With both manufacturing capex and exports under pressure as long-term sources of growth, Beijing knows it must pivot to domestic consumption, and its policymakers have been announcing as much publicly. But they will need to put money behind those statements, and we expect them to do just that throughout 2026. One way to do that may simply be to allow CNY to appreciate. It would also allow other Asian currencies to appreciate relative to the dollar. A stronger CNY might hurt exports but could help domestic consumption, especially when combined with other forms of domestic fiscal stimulus. At the moment it is still unknown if this will actually happen.
Despite all this, we are still positive on Chinese equities mostly because of the still attractive valuation and decent profit growth.
Gold and Silver
Gold and silver have sold off significantly on the news that President Trump would appoint Warsh as the next Fed Chair. We think that any deep analysis of potential Warsh moves based on his previous statements would be a mistake. It was President Trump’s tacit commitment to Fed independence by appointing ‘hawk’ Warsh that caught the attention of the precious metal bulls.
Speculative forces appear to have driven gold and silver’s recent surge. The magnitude of silver’s rally looks excessive against the backdrop of relatively disappointing industrial sector demand. High silver prices will lead to some demand destruction. There are already signs of demand-side adjustment to higher silver prices.
Last year’s run-up in gold and silver prices seems to have been driven by retail investors, with ETF inflows now dominating as central bank buying has actually slowed. Could global central banks continue to increase gold as part of official reserves? Perhaps, but the world’s central banks are now at 20% gold in official reserves. Sure, gold reserves could go higher and diversifying into gold makes a lot of sense, but a fifth of total reserves seems like a reasonable level.
In other words, central banks might not be buying a lot more. Therefore, we think precious metal prices could still go up but we doubt precious metals will continue to outperform. Technical indicators for silver are presently pointing to extremely overbought conditions, warning that a major shakeout is likely. Gold still offers the most compelling risk-reward profile among the precious metals complex.
Our Portfolio Positioning
Overall, we remain positive on global equity markets, as fundamental economic drivers remain in place. Additional stimulus in Europe, Japan, and China will only power global economic growth.
We continue to favor international diversification, as we believe international markets can outperform. Therefore, we increased the portfolio overweight in Emerging Markets, while maintaining an overweight in Europe. We also diversified the portfolio to global small caps, which we think will be key beneficiaries of agentic AI applications.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Institute for Supply Management (ISM) Manufacturing Index shows business conditions in the US manufacturing sector, taking into account expectations for future production, new orders, inventories, employment and deliveries. It is a significant indicator of the overall economic condition in US. The ISM Prices Paid represents business sentiment regarding future inflation. A high reading is seen as positive for the USD, while a low reading is seen as negative.
The MSCI ACWI Indexis a free float‐adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWIconsists of 46 country indexes comprising 23 developed and 23 emerging market country indexes.
Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest. An investment in the Fund involves risk, including possible loss of principal.
Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Smaller capitalization securities involve greater issuer risk than larger capitalization securities, and the markets for such securities may be more volatile and less liquid. Specifically, small capitalization companies may be subject to more volatile market movements than securities of larger, more established companies, both because the securities typically are traded in lower volume and because the issuers typically are more subject to changes in earnings and prospects. Compared to large companies, small and medium-sized companies may face greater business risks because they lack the management depth or experience, financial resources, product diversification or competitive strengths of larger companies, and they may be more adversely affected by poor economic conditions. There may be less publicly available information about smaller companies than larger companies. In addition, these companies may have been recently organized and may have little or no track record of success.
