Young & Invested: Is this the strategy for 2026 and beyond?
What last year’s market rotation might be signalling.
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 48
As we move into the new year, the usual parade of forecasts to the tune of “is it time to invest in X?” have arrived right on cue. It’s an entertaining ritual. The title of this column is my small contribution to the tradition.
Although I will admit I’m hardly immune to the impulse behind all this. Many investors are currently trying to make sense of the past 12 months and the future implications. Importantly, it signified a subversion of what many had come to see as the natural order of markets.
According to some, it was also a pretty hard year to lose money in the market. Unfortunately, I can’t attest to that (at least not on paper). Mainly because I indulged in doing something I’d sworn off: dabbling in individual stocks. The results were educational to say the least, but that’s a story for another time.
2025 was a standout for a multitude of reasons. Every news alert, forecast or policy announcement left us holding a breath before opening our accounts. Despite the volatility, every major asset class finished the year in positive territory. Most notably, emerging market (EM) equities staged their biggest rally in over a decade, surging 30% compared to 17% return for the US market. This marked a meaningful resurgence after years of lagging developed equities.
European equities also outpaced the US which is something that would’ve sounded delusional a few years ago. It was the kind of year that tempts us to draw sweeping conclusions about slowing growth in the US.
But are narratives born from a single year entirely reliable? Or was it simply a unique combination of factors providing a tailwind? Whilst I won’t be discussing the merits of investing in emerging markets, the primary question here is the implications it has for investors.
A long anticipated rotation
The resounding theme centred on whether US exceptionalism could persist, amid uncertainty around the second Trump administration. It wasn’t a doomsday call on US equities, but there was a noticeable softening in conviction. Concerns about extreme levels of concentration, stretched valuations and an unsettled geopolitical backdrop all contributed to this.
Part of this move reflected a slow drift away from the more expensive corners of the market e.g. US mega-caps. At the beginning of the year, EM equities looked comparatively inexpensive and tied to a very different set of economic drivers.
In recent years, many Aussie investors have found international diversification beyond the US hard to justify, however nothing remains static. Diversification can feel pointless right up until the moment it isn’t.
A weakening US dollar
The US dollar cycle has historically coincided with cycles of developed market and EM outperformance. Stronger periods of US dollar performance have correlated with weaker EM performance.
According to Morningstar Portfolio Strategist Amy Arnott, expectations of slower growth, concerns about rising federal deficits and global central banks attempting to diversify their reserves all weighed on demand for dollar‑denominated assets.
The currency fell around 8% against a basket of global currencies. This provided a tailwind for companies in emerging markets that tend to benefit disproportionately in an environment where US-denominated debt‑servicing costs are lower. Often this also comes hand in hand with an improved investor sentiment towards EMs that drive capital flows.
What it represents for investors
Whether or not your portfolio is positioned to bet on the collapse of US market exceptionalism, it’s understandable to go searching more broadly when expected returns for old favourites dip lower. EMs sit squarely in that conversation for several reasons.
Firstly, their economies are projected to grow nearly twice the pace of developed markets, whilst offering less correlation with US equities than other developed market benchmarks. The challenge here for most investors will be their ability to capitalise on some of this growth.
Source: VanEck. Growth premium remains key edge.
Broad diversification has also been another part of the appeal. Most developed-market benchmarks have almost moved in lockstep with US equities in recent years. By contrast, EMs are shaped by a distinct economic cycle. The lower correlation can offer a breath of fresh air when it feels like the rest of our portfolios are increasingly being tied to the same handful of outcomes.
While traditional headwinds such as currency pressure ease, concentration in the US market has reached uncomfortable levels that leave little room for disappointment. You don’t need to believe in an impending dot-com style crash to feel uneasy.
Against that backdrop, it’s not surprising that investors are reconsidering where future growth might come from. Of course, none of this guarantees the continued dominance of the EM segment, however it does offer some insight into the story that many investors are painting.
Source: Morningstar Global Outlook Report.
Beware the recency trap
As humans, we are naturally inclined towards recency bias. That is, the tendency to believe what has recently occurred will continue to do so. What was once likely an evolutionary survival mechanism has grown into one of the biggest pitfalls in investing.
When markets rise for long stretches, e.g. US mega-caps, it’s easy to assume that this momentum is a somewhat permanent state of affairs. Long bull markets create a sense of comfort and encourage us to take more risk whilst loosening the guardrails around what we know about portfolio diversification and discipline. But what goes up must come down, and the market cycles don’t announce their arrivals in advance. When conditions turn, those who have built their portfolio based on yesterday’s optimism might absorb the sharpest losses.
Some argue that this behavioural pattern has reinforced the rise of passive investing. It seems automatic flows into broad US and Australian index funds have become the default for many, regardless of how stretched valuations may appear. They’ve created a sense that whatever has done well recently must be the safest place to be. I previously explored the implications of that thinking here.
This matters in the context of a standout year for any market segment or asset class. It’s tempting to treat performance as a resounding signal, rather than the outcome of several intricate factors that might not persist. I don’t discuss any product, asset class or thematic without underscoring this point. And EMs are no different.
The chart below from BlackRock ranks the annual returns of select asset classes from highest to lowest over the past decade. We see that the order shifts randomly across the years, indicating the futility of rotating into the previous year’s winners.
Source: Blackrock. Asset return map.
Concluding thoughts
It’s tempting to draw conclusions from what has just occurred and sketch out how you can optimise your portfolio to recreate it. But if the past few years have taught us anything, it’s that markets don’t care about our arbitrary calendars or tactical tweaks. They move on their own schedule that’s indifferent to our attempts to anticipate them. The things that genuinely move markets e.g. the Covid-19 pandemic, are almost always the ones that nobody saw coming. That is why I stay wary of the urge to constantly recalibrate. The odds simply don’t favour intricacy.
So should you add emerging market exposure because it experienced a strong 2025? Probably not. But that’s more a comment on individual investor behaviour than on the market segment itself. The same could be said for any number of last year’s winners.
There will always be a portfolio that outperforms yours in retrospect. That doesn’t mean it’s the right approach for the future or for your specific goals. Staying grounded to your objectives and strategy is essential to avoid the temptation of over-complicating your portfolio in pursuit of infinite outperformance.
Comparison is a thief of joy. Something I recently realised when deep cleaning a second‑hand couch on a Sunday night to realise it was probably treated as both a bed and bathroom for the former owner’s dog.
