Resilient Growth, Stretched Valuations

Valuations and Expected Returns

The U.S. equity market trades at roughly 25x earnings. Historically, from these valuation levels, the average real return of equities over the following ten years has been close to zero. This does not necessarily imply an imminent decline, but the long-term risk/return profile for the index as a whole is unappealing.

Confirming this caution, Warren Buffett—while remaining structurally optimistic about American capitalism—is holding the highest cash level ever at Berkshire Hathaway. The “cash pile” has reached a record high, signalling a scarcity of opportunities at reasonable prices.

Fiscal Policy and the Dollar

U.S. fiscal policy remains highly expansionary: the federal deficit consistently runs above 5%–6% of GDP, and the Congressional Budget Office expects deficits around or above 6% for the entire Trump presidency.

What is notable is that the U.S. is spending at such levels during a period of full employment and still-favourable financial conditions—historically seen only in recessions or wartime. This combination of:

• high deficits
• rising debt
• a monetary policy stance likely less restrictive in 2026 than in 2023–24

points to a structurally weaker dollar over the medium-term, especially relative to currencies of countries with more disciplined public accounts and/or trade surpluses.

Big Tech and the “Magnificent Seven”

The seven major American tech giants are allocating a substantial share of their cash to both structural investment (CAPEX) and ongoing operating costs (OPEX) related to AI (data centres, chips, models, talent). This compresses short-term free cash flow and Return on Capital Employed (ROCE), which is already declining. However, these investments are almost mandatory to defend technological leadership, especially against Chinese competitors.

From a portfolio perspective:

• AI remains a strategic theme
• investors should expect margin pressure and elevated volatility
• there is a concrete risk that future returns may fall short of exceptional past performance, given high multiples combined with declining returns on capital.

Artificial Intelligence: Higher Productivity, More Fragile Employment

Generative AI promises substantial productivity gains across many sectors (software, financial services, marketing, manufacturing, healthcare). Companies that adopt it quickly and effectively will see:

• lower operating costs
• automation of repetitive tasks
• ability to scale revenue with less staff.

However, this also entails:

• more layoffs or non-renewal of administrative and back-office roles
• social tensions and potential regulatory responses.

For equity markets, this means greater dispersion—rewarding companies that integrate AI effectively and penalising those that lag behind or operate in easily automated sectors without strong pricing power.

Defence and Infrastructure are not enough to offset all risks

In 2026, Europe is expected to grow just above 1%, with Germany slowly recovering after years of stagnation and a projected growth rate of around 1.2% annually in 2026–27.

Positive Drivers

• Structural increase in defence spending, with EU budgets rising sharply (estimated €381bn in 2025, +10% y/y)
• The German infrastructure fund and additional public investment plans supporting construction, energy, and digitalisation.

Negative Drivers

• Increasingly aggressive Chinese competition in Europe’s core sectors (automotive, machinery, chemicals, renewables)
• Structurally higher energy costs relative to the U.S. and parts of Asia.

Europe is not devoid of growth engines (defence, green transition, digitalisation), but struggles to translate them into a strong equity cycle at the index level. Value is increasingly concentrated in specific segments and individual stories rather than in broad exposure to the Euro STOXX 600, albeit starting from more attractive valuation levels.

Excess Capacity, Deflation, and Industrial Pressure on Europe

China is aggressively expanding advanced manufacturing and R&D, creating significant overcapacity in sectors such as electric vehicles, batteries, solar, and other “green” technologies.

This results in:

• goods deflation exported to the rest of the world
• immense competitive pressure on European and, to a lesser extent, U.S. industries.

For Europe, the risk resembles a new “China shock”, which:

• erodes market share for manufacturing firms
• compresses margins
• makes tariffs and trade defence measures politically sensitive.

China is currently allowing its currency to weaken as needed to support exports and growth, but persistent surpluses and domestic deflation may eventually favour a gradual renminbi appreciation against currencies of chronically deficit-ridden countries—particularly the fiscally expansionary U.S. dollar. The timing, however, remains highly uncertain due to strong administrative control over the exchange rate.

The Credit Story in an Era of Expensive Equities

Recent months have seen a somewhat unusual combination, reminiscent of the late 1990s during the TMT bubble (Technology, Media & Telecom):

• equity indices at elevated valuations
• credit spreads—especially investment grade—near decade lows (around 100 bps over euro government bonds, levels seen only a few times outside the early 2000s).

Four historical lessons emerge.

Lesson 2. The Hyperscalers of Today Mirror the Telecoms of the Late ’90s—Spreads rose because of leverage, not defaults

The true parallel today is not the unprofitable Nasdaq of 2000, but the highly profitable telecom companies of the late 1990s that:

• had strong cash flows and initially moderate leverage
• embarked on massive re-leveraging to finance new infrastructure (fibre networks, internet backbone, 3G licenses)
• spent over $500bn in the U.S. and Europe over five years—mostly financed with debt.

Spread widening in the late 1990s was driven by:

• an explosion of debt issuance (record high yield and investment-grade supply, heavy share of B-rated debt)
• investors demanding higher risk premiums to absorb the volume.

Defaults rose only after the bubble burst (2001–02), when spreads were already wide.

Today we see a partial echo:

• AI/cloud hyperscalers are highly profitable but undergoing extraordinary CAPEX cycles
• an increasing share of funding comes from bond markets, with large investment-grade issuances in both USD and EUR.

The parallel has limits: these investments are currently financed only marginally through debt and are largely covered by earnings.

European subordinated financials combine:

• stronger fundamentals than pre–Global Financial Crisis (capital, liquidity, NPLs)
• regulation that reduces the likelihood of excessive leverage
• still meaningful extra spread over senior and corporate investment grade that compensates structural risk.

Lesson 4. Tight Bank Spreads Do Not Mean the Rally Is Over—The Pre-GFC Parallel

Today’s credit spreads are among the lowest of the decade. Many European investment-grade segments trade around 100bps over government bonds—tight in recent historical terms.

Before the Global Financial Crisis, bank spreads—especially among core issuers—were even tighter. The business model is evolving into one increasingly “utility-like” and heavily regulated, with limited incremental leverage and strong capital/liquidity oversight.

In such a regime:

• banks behave more like regulated utilities
• are less exposed to aggressive leverage cycles
• undergo constant stress testing and stringent prudential requirements

Further spread compression—even in subordinated paper—would not be irrational.

Conclusion

Many past dynamics are reappearing:

• in the late 1990s, the TMT bubble inflated for years while spreads widened
• the real fault line lay in re-leveraging the “infrastructure of the future” (then telecoms, today AI/cloud)
• those who built the networks were not necessarily those who earned the final profits
• post-bubble, financial credit—especially subordinated—delivered the best relative performance.

A bond strategy consistent with these lessons remains appropriate for the next six months.

Different Speeds, Different Cultures

2025 proved a challenging transition year for discretionary spending, with the first six months marked by political uncertainty in the U.S. Volatility tied to Donald Trump’s return and his stance on trade policy weighed on consumer confidence, which—according to the University of Michigan—remained stubbornly below 70, well under pre-pandemic levels.

The Apparel & Footwear segment was among the hardest hit, due to heavy production exposure to Asian countries such as Vietnam and Cambodia, following steep tariff tightening that dampened demand and intensified promotional pressure. In the second half of the year, conditions improved: core inflation fell below 3%, real wages turned positive, and political narratives stabilised. Consumer confidence improved, with a greater focus on quality and more optimistic expectations for 2026.

Looking Ahead

2025 ended with encouraging signs for the Apparel & Footwear sector, which is benefiting from structural trends more resilient than short-term volatility.

According to Euromonitor, the global apparel and footwear market—now worth about $1.8 trillion—is expected to grow at 5%–6% annually through 2030, driven by the expansion of the Asian middle class and the rising penetration of athleisure, which now represents over 30% of total apparel consumption in the U.S.

Demographic dynamics strengthen the picture: Millennials and Gen Z are allocating an increasing share of discretionary budgets to wellbeing, performance, and lifestyle-related products. More than 60% of respondents in a McKinsey survey say they intend to spend the same or more in 2026 on premium or technical categories. This cultural shift towards quality, comfort, and brand identity suggests a favourable environment for the sector in the new year.

A Multi-Speed Sector

A look at the performance of individual companies in the Apparel & Footwear space reveals a dynamic landscape: major incumbents are navigating complex repositioning cycles; agile, highly innovative newcomers are gaining market share, reshaping competitive boundaries.

Key Factors to Monitor

• China: major catalyst (or drag)

China accounts for around 18% of the global premium market. In 2025, fashion sector growth in major cities was just +2%. A return to +6%–7% would immediately benefit international brands; a weak recovery would keep the sector on a more cautious trajectory.

• The new geography of the supply chain

Over 55% of global footwear is produced across Vietnam, China, and Indonesia. In 2026, the pace of diversification toward India, Mexico, and North Africa will be crucial: even a 5%–10% shift can materially reduce tariff risk and improve lead times.

• Wholesale 2.0 and the DTC rethink

DTC offers higher margins but exposes brands to greater risk when volumes slow: higher fixed costs, more inventory, and heavier promotional pressure. Tariff uncertainty adds further complexity: with consumer confidence still below historical averages, passing cost increases onto buyers becomes harder. As a result, 2026 will be the year of rebalancing, with wholesale offering resilience and posting +8% sell-through in 2025 for many challenger brands.

• More demanding consumers, less loyal

Loyalty is declining: in 2025 only 34% of consumers repurchased from the same sports brand (vs 45% in 2019). In 2026, brands with authentic storytelling, strong perceived quality, and products aligned with key trends—wellness, comfort, identity—will be best positioned.

Conclusion

Overall, the Apparel & Footwear sector enters 2026 with significantly more favourable prospects than the previous year. Normalising inflation, a less unstable political backdrop, and more manageable comparison bases should support a gradual improvement in demand. It is also difficult to imagine uncertainty levels comparable to 2025, particularly concerning tariffs and consumer confidence.

In a more predictable environment, brands with clear identity and distinctive positioning will be best equipped to stand out.

Thus, 2026 begins with a more balanced sector and meaningful upside potential, where the ability to select the most solid and culturally relevant brands will be key to capturing the opportunities of the new cycle.