Rising risks and hidden opportunities drive 2026 markets

Text transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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David Wong, group chief investment officer, CIBC Asset Management 

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The three big-picture takeaways from the markets in 2025 are all related. And the first one would be that bad headlines didn’t lead necessarily to poor performing markets. In fact, it’s been quite the opposite. 

You know when we came into 2025, we had lots of concerns in the headlines around the Canadian economy. We had the overhang of tariffs on the horizon. We had ongoing productivity problems, which have been plaguing Canada for quite a few years now. And yet, the Canadian stock market returned just shy of 30% for the first 11 months of 2025. 

And that’s been the strongest showing for our stock market since 2009. So it’s been 16 years since we’ve seen returns this strong despite the headlines. And it wasn’t just Canada that had the negative headlines coming in that surprised with the positive market results. 

Tariffs were impactful the world over, but overwhelmingly, the stock markets across the globe were positive. The developed international markets, which are represented by the EAFE Index, that’s Europe, Australasia, and the far east, those markets did exceptionally well, with returns of around 24% for the first 11 months, which is the best showing since 2013.  

And emerging markets were up 26%, which interestingly, was the best result since 2017, which was the last time Donald Trump, in his initial presidency, had a first year into that presidency. So interesting environment and backdrop for all of the markets.  

The second big takeaway was that the U.S. didn’t lead the global equity markets for a change, despite the Magnificent Seven cohorts of Nvidia, Microsoft, Meta, Alphabet, Amazon, Apple and Tesla. They all outperformed the index once again, on average.  

Mag Seven was up around 23% in 2025, so far leading up to early December here. And the rest of the index is up just under 7% in the U.S. And so the U.S. market had really, better earnings growth than other markets in 2025. And yet the P/E ratios of markets in Europe, Japan and the emerging markets expanded more than the U.S. market did. 

And since 2011, the U.S. has been the outperformer relative to these other markets 9x out of the past 14 years, which is more than 60% of the time. But this was a year that the markets outside of the U.S. were really willing to price in some multiple expansion in anticipation of growth in the forward view in some of these other markets.  

And the third big takeaway from 2025 is that the year was a perfect reminder of why it’s so important to stay disciplined in our portfolios, and stay diversified in our strategies. You know, the discipline was needed in the face of all of those fearful headlines that we saw, and the diversification was needed to benefit from the returns that were stronger outside of the U.S. market, when it’s been all too tempting to put all of our eggs in one big momentum basket.  

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When we think about the most compelling risk-adjusted opportunities for 2026, you know we need to really think about the setup for the markets heading into the year, and the implication for those return opportunities. 

And unfortunately, the headlines heading into 2026 remain much the same as they did throughout 2025, which is, you know tariffs are still going to enter the conversation on the Canadian economy as CUSMA or USMCA is up for review in the middle of 2026.  

We have the conflicts in Ukraine and the Middle East. They’re still complicated. They’re still unresolved, unfortunately.  

And investors still remain concerned about valuation in the equity markets broadly. So against this backdrop, it’s hard to find the obvious bargains out there with valuations above historical levels across the equity markets around the world. And, you know, we saw a lot of enthusiasm already expressed by investors in 2025.  

Now, positively, earning growth has justified the increase in stock prices in many cases — Nvidia, perhaps being the poster child for strong market returns. You know, it’s seen its share price rise significantly over the past three years since the AI theme really took off. But its earnings growth has matched the pace almost one-for-one. If anything, the earnings growth has slightly outpaced the stock market return. And so, we’ll need to see a similar path of earnings growth for stocks like this to continue to do well. 

And it is a little tough to bet against this given the promise of productivity gains that AI proponents have really forecasted into the future here. Now, of course, we could look at the underperformers over the past year or past several years to see if there’s anything, you know, unjustifiably ignored relative to the forward prospects.  

In Canada, you know while the market as a whole returned close to 30%, that mainly came from three sectors: materials, with gold stocks in particular doing well, financials and consumer discretionary. You know, those were the only sectors that were in the strike zone of that overall 30% return.  

And the remaining eight sectors in the index represent roughly half the stock market capitalization. They underperformed the index. And three sectors, in particular, industrials, real estate and healthcare, had returns of around 2% or less. So it’s giving bargain hunters some opportunities to turn over some stones.  

In the U.S., we’ve witnessed some extremes in historical patterns around diversification. The S&P 500 equal weighted index versus the market cap-weighted index is underperforming at levels that we haven’t seen for a few decades now. So we can think of the equal weighted index as really a more diverse representation of all the stocks in the general version of the S&P 500, which, of course, is heavily concentrated in the top 10 names today.  

And in the 36 years that we have data for the equal weighted index, you know the returns for both the market cap-weighted and equal weighted index are roughly the same. It’s about 11.7% annualized versus 11.4% annualized, slightly favouring the equal weighted indexes.  

On a three-year rolling basis, however, so today the difference between those indexes is about 9.9% annualized in favour of the market cap-weighted version of the index over the last three years. Now this is as extreme as we’ve seen since about March of 2000. That’s the last time that the difference between these indexes was north of 10% in favour of the market cap-weighted index. And then we all know what happened after March of 2000. The dynamics started shifting in favour of the equal weighted index for a very long time after that.  

And so it’s not that the AI story isn’t exciting, which is represented in that market cap-weighted index in a very concentrated way. It’s not that that story isn’t exciting. It’s just that after a certain point, the math on the winners becomes challenging. And so, getting more diversification into portfolios is a good idea with the top 10 names in the S&P 500 now at over 40%. And so active management has tended to do better than the markets during periods when diversification has been rewarded.  

Now, if we look across at the bond markets, you know investment-grade bond yields remain reasonably high in this environment. In Canada, the 10-year government of Canada bond yield is hanging out in the 3.3% to 3.4% range. And we need to keep in mind that these bond yields were well below 1% just five years ago. And so they’ve stayed in this current, you know, north of 3% range now for a few years, despite a very different inflation environment than was present when yields first spiked in 2022. And so, there’s an opportunity to get decent yield in the portfolio and diversification. 

In 2025, we started seeing bond yields really act as a diversifier against equity markets when they were down in 2025. So if risks pick up, you know, in 2026, and there’s a flight to quality, there could be some decent diversification potential from bonds at these levels. Otherwise, you know we’re in a position now to get a pretty decent return on a lower risk asset class in general. 

And so, when it comes to finding the most compelling risk-adjusted return opportunities for 2026, it remains important to not put all your hopes into a single year or a single idea. And keep in mind that a disciplined plan that emphasizes a return that compounds over time, rather than trying to speculate in a binary way, is a time-tested approach for building wealth towards your goals. 

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As far as the most underpriced risks heading into 2026, and positioning and hedging around these risks, I think it’s important, you know, to reflect on some of the more well-known risks heading into 2026. That includes interest rate direction in the face of lingering inflation, the odds of a recession given delayed tariff impacts, and of course, when the market will start to correct given the higher earnings multiples. Those seem to be the things on the top of many investor minds.  

Overall, the economic data does look healthy. Certainly, we haven’t seen weaknesses many were expecting given the headwinds that we’ve witnessed so far in 2025. However, there are signs of concern. 

The so-called K-shape of the economy seems to be real, with consumer spending being driven by the highest income earners, while the lowest income cohort struggles. And the job market seems to disproportionately favour experienced over less experienced workers. So while the data say things are okay overall, there is a large contingent of individuals that are feeling what has been colloquially called a vibecession, which describes a situation when the economy is superficially in decent shape, but many are feeling the pain of higher prices and limited opportunities. 

Now, we know that the impacts of artificial intelligence on the labour force is developing very rapidly here. We don’t quite know what magnitude, or even what form this will take on with any certainty today. We do know that AI adoption has been very fast, and this could lead to a period of adjustment that will take some time for the economy to digest. 

In the past, with other game-changing technologies, economies had more time to acclimate since their adoption was slower. For example, it took the internet seven years to reach 100 million users, whereas ChatGPT reached that level within two months. So while the internet did ultimately shift the type of work that people did, the evolution was quite slow by comparison. 

And so this could lead to some discomfort in the near term with the adoption of AI. And so we don’t know the exact amount that AI will ultimately impact earnings. We believe it will be positively impactful, and potentially in a very big way for the economy. 

Now, amidst this tug of war between economic uncertainty, high valuations and disruptive growth, we believe that the most underpriced risk is the risk of being too influenced by this type of noise, rather than following a disciplined plan that suits your investment horizon. Now, we know that developed equity markets have positive returns in, you know, 65% to 70% percent of calendar years historically, and they’ve not failed to deliver positive returns over 20-year periods looking in the rear view. So investors should position themselves according to their liquidity needs. 

The best way to hedge is to be diversified in the markets. Where we do have clients that are able to withstand the short-term bumps in the road, we are diversified well beyond Canada and well beyond the U.S., and into things like international stocks and emerging markets. We invest in bonds from around the world, from government and corporate borrowers, and we have exposure in alternative assets like private equity, private credit and private real estate. 

Now, even within the more liquid markets, we have some hedges with defensive strategies, like low-volatility portfolios, that are proven to be effective on days that the broad markets have sold off. And so, this is one additional way to add some ballast to an asset mix. Overall, we are confident in the resilience of the markets over the long term, but believe that building in diversification in the current environment could be a source of comfort in 2026.

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