Monthly Market Commentary - January 2026

For the third year in a row global stock markets managed to post double-digit gains, with the MSCI All Country World Index returning 14.4% in 2025 (all returns for 2025, total and in sterling, unless otherwise stated). UK and European stocks were the standout performers last year, following two years of US equity outperformance, demonstrating the value of portfolio diversification. Bonds also provided a notable return, with gilts up 5.0%.

UK and European exceptionalism

Returns of 25.8% for the MSCI UK and 27.2% for MSCI Europe ex UK were particularly strong, comfortably above the 10.3% from MSCI North America. A good portion of the outperformance can be explained by foreign exchange movements as sterling appreciated 7.7% against the US dollar. That said, even without this move the UK and Europe would have clearly outperformed the US, supported by diverging fundamental developments on either side of the Atlantic.

Government tailwinds and headwinds

Large-scale government spending plans on defence and infrastructure provided a major positive tailwind for European stocks, while US equities faced a headwind of increased trade tariffs following Donald Trump’s “liberation day” announcement in early April. Although Trump’s apparent strategy of escalate-to-de-escalate has seen levies reduced from their most punitive levels, they remain far higher. The weighted applied tariff rate on all US imports has risen to 15.8%, according to the Tax Foundation. Behavioural changes mean the effective rate has risen less, up to 11.2%, but it is still far higher than the 2.5% effective tariff rate in 2024.

UK equities

The stellar return of UK stocks in 2025 was driven by rising geopolitical tensions, higher commodity prices and a strong performance from financials which make up a notable proportion of the index. Defence and aerospace stocks benefitted from increased government spending commitments while mining stocks gained on the back of surging precious metal prices, as gold prices rose 64.6%. The environment was supportive of bank shares, due to low default rates, relatively high net interest margins and sizeable dividend and share buyback programmes. Valuations were also relatively attractive, particularly compared to US equities.

UK Autumn Budget — spend now, tax later (maybe)

After months of speculation the Autumn Budget had an almost anti-climactic feel about it, with many of the measures not due to kick-in for a number of years — in some cases after the next election. The lion’s share of the £26bn additional taxes will go towards increasing chancellor Rachel Reeves fiscal headroom to £22bn, more than twice the buffer given in 2024 which, after being wiped out, led to heightened uncertainty and was seen as weighing on economic activity. Disappointingly, the Budget will not provide any boost to growth, according to the OBR (Office for Budget Responsibility). Although the UK is expected to have been the second-fastest growing G7 economy in 2025, according to the IMF, there has been a notable slowdown in recent months.

Softening UK data supports rate cuts

A combination of slowing growth, rising unemployment and cooling inflation led Bank of England policymakers to cut interest rates in December, taking the base rate to 3.75%. Since August 2024 the rate has been lowered six times, each time by 25 basis points (0.25%). After a strong start to 2025, it became apparent that economic data was cooling but stubbornly high inflation prevented a faster pace of rate cuts. A drop to 3.2% from 3.6% in the latest consumer price index is welcome, but UK inflation continues to run higher than peers. Four of the nine-member panel that determines interest rates voted against a reduction last month and we will likely need to see inflation fall further to justify additional rate cuts.

Gilts

Interest rate cuts and falling inflation have supported bonds in recent months and overall, 2025 was a solid year of returns with lower volatility than seen in stocks. The sweet spot for investors was 5-15yr gilts (5.9%) which benefitted from interest rate cuts while not being impacted as much as 15yr+ gilts (3.7%) by higher inflation. UK investment grade corporates returned 7.3%.

Conclusion

Financial markets provided strong returns in 2025, despite a number of negative headlines. The volatility in early April following the US tariff announcement shows the importance of maintaining a long-term perspective and not making knee-jerk reactions — stocks fell more than 10% in a matter of days before bouncing strongly to recoup the losses and reach new highs just a few weeks later. After a very strong run higher, US tech valuations are elevated, and we now see risks as more evenly balanced than they were a couple of years ago. We believe AI is a potentially transformative technology and there remains considerable growth potential ahead, but the picture is uncertain and for investors this means diversification is crucial.

Overall, we believe the outlook is normalising, although several risks remain which could lead to lower growth and/or higher inflation. The chances of a recession are lower than six months ago, and we prefer to be invested. With growth and earnings outlooks positive the backdrop appears favourable for stocks, particularly in Europe and Emerging Markets. Fixed income continues to offer attractive yields but there are risks around inflation and the sustainability of government debt levels. Credit spreads remain very tight but with some justification given the current benign economic backdrop.