The “everything rally” sweeping global markets this year may prove fragile despite investor optimism over artificial intelligence (AI) and monetary easing, according to DBS Bank’s Chief Investment Office (CIO) in its 3Q25 Insights: Ride The Trend report.
The bank said risk assets from equities and gold to cryptocurrencies have surged in 2025 as investors bet on aggressive rate cuts by the US Federal Reserve, even as policy and fiscal headwinds mount. Futures markets are now pricing nearly five Fed rate reductions by the end of 2026.
“The extraordinary melt-up is set to persist as the Fed embarks on monetary easing,” DBS noted. “Yet it is a curious irony that investors show such exuberance when the US effective tariff rate is at its highest since the 1930s.”
The bank cautioned that surging tariffs and renewed fiscal spending under President Donald Trump’s “One Big Beautiful Bill” have fuelled concerns over fiscal profligacy, driving long-term Treasury yields higher and the dollar lower. US government debt has now exceeded 120 per cent of GDP, heightening fears of “fiscal dominance”, where fiscal needs begin to dictate central bank policy decisions.
Stagflation-lite Risks Emerging
DBS expects the debate around “stagflation-lite” to dominate market discussions in the coming quarters. The report cited signs of resurgent inflationary pressures even as growth momentum slows, a combination that risks undermining corporate earnings.
“The negative impact of tariffs is simmering beneath the surface,” it said. “While optimism around AI’s transformative potential drives sentiment, projections suggest heightened stagflation risks.”
DBS observed that investors’ enthusiasm remains anchored in expectations of robust corporate earnings in 2025 and 2026, fuelled by heavy AI-related capital expenditure. However, it warned the rally’s underlying structure is vulnerable, pointing to overconcentration and valuation risks.
The top ten companies — mostly in technology — now account for 38 per cent of the S&P 500, compared to 20 per cent in 1995. “These firms’ heavy investments in AI may not yield the expected returns,” DBS said, adding that this concentration exposes the market to potential correction risk.
Valuations are also flashing warning signs, with the S&P 500’s forward price-to-earnings ratio hovering near historical extremes, even as broader earnings forecasts remain flat. Outside Big Tech, earnings momentum is showing signs of fatigue, and margin compression from tariffs could prompt downgrades ahead.
‘Ride The Rally, But Protect The Downside’
DBS maintained that risk assets could continue climbing in the short term, buoyed by Fed easing, “Goldilocks” macro conditions, and AI-driven capital expenditure. Yet it urged investors to remain cautious and diversify portfolios to protect against downside risk.
“Our strategy is to ride the rally but protect your downside,” the CIO report said, recommending a balance between cyclical optimism and defensive positioning.
The bank raised its weighting on US equities to neutral, doubling down on its conviction in technology. It also recommended adding positions in Asia ex-Japan equities to capture valuation discounts and potential upside from a weaker dollar and Fed easing.
To hedge against potential volatility, DBS suggested exposure to gold, hedge funds, and private assets.
The report noted that bonds are regaining favour among investors as equity fund flows slow. The US earnings yield gap versus the 10-year Treasury has turned negative, supporting a preference for fixed income.
“Bonds are currently favoured over equities,” DBS said, highlighting steady US GDP growth and stable wages. Corporate earnings are projected to expand by 12 per cent in 2026, but higher bond yields and fiscal uncertainty warrant caution.
The CIO maintained a cautious stance on ultra-long bonds, citing “persistent inflationary pressures and doubts over the Fed’s credibility amid rate cuts”. Instead, DBS prefers investment-grade (IG) corporate credit over government bonds, favouring high-quality issuers in the A and BBB categories.
Alternatives And Real Assets In Focus
The report underscored the rising importance of alternative assets in navigating volatile markets. DBS advised overweighting real assets such as private infrastructure and gold as the US embarks on both fiscal and monetary easing.
Private infrastructure assets offer inflation-protected, long-term cash flows, particularly in utilities, while gold remains a key hedge against monetary debasement and geopolitical uncertainty.
Gold has already surpassed USD 3,400 per ounce this year, reflecting investor anxiety over de-dollarisation and policy instability. DBS projects the precious metal to reach USD 4,450 per ounce in the first half of 2026.
“Quantitative analysis shows that a hybrid portfolio of semi-liquid private assets and hedge fund strategies outperforms pure equity and 60/40 portfolios over a decade,” DBS said, positioning alternatives as essential to modern portfolio construction.
In its macro outlook for 4Q25, DBS said the Fed’s rate cuts are proceeding under political pressure, even as tariff-driven inflation risks linger. A steeper yield curve and rising long-term bond yields could challenge financial stability.
In the Eurozone, GDP growth is expected to soften in the second half of 2025 to 1.2 per cent, with domestic demand and defence spending as key drivers. The European Central Bank’s rate-cut cycle is likely over unless growth deteriorates sharply.
Japan, meanwhile, faces external pressures from weaker exports but remains supported by resilient domestic consumption and gradual rate hikes by the Bank of Japan. DBS downgraded Japan to underweight for the quarter.
Asia ex-Japan remains a relative bright spot. DBS expects “compelling upside driven by steep valuation discounts, resilient earnings, and supportive capital flows”. China’s pro-growth policies and ASEAN’s fiscal stimulus are expected to sustain regional momentum despite global headwinds.
Credit, Currencies And Commodities
DBS remains positive on short-duration, high-quality IG credit and suggested extending duration only when 10-year US Treasury yields exceed 4.5 per cent. High-yield bonds, however, face valuation challenges as spreads remain tight and default risks rise.
In currency markets, DBS expects the US dollar’s decline to moderate in the near term as rate cuts are already priced in. The euro and Australian dollar are likely to outperform, while sterling and the yen may lag due to fiscal and policy constraints.
In commodities, growth-linked sectors are expected to remain subdued under tariff pressures, but DBS sees selective upside in precious metals, rare earths, and certain agricultural products such as coffee, citing strategic demand and supply constraints.
DBS’s overarching message is clear: the global “everything rally” of 2025 rests on a precarious foundation. AI optimism and policy easing have powered a remarkable rebound across risk assets, yet structural imbalances — from record debt levels to inflated valuations — are rising in tandem.
“With investors caught between a rock and a hard place,” the report concludes, “the prudent strategy is to ride the rally but stay hedged through diversification.” |
