The macroeconomic data for the main developed economies remain broadly strong. Equity sector rotation intensified over the past few weeks.
The eurozone economy beat expectations to grow 0.3% in the fourth quarter of 2025, reflecting solid momentum within the zone. At 1.5%, GDP for full-year 2025 grew at a faster pace than in 2024, despite heightened geopolitical tensions and rising protectionism. Recent movement in the PMI leading indicators – with the composite index at 51.3 points in January – signals growth above 1% in 2026, supported by accommodative fiscal policy and higher spending on defence and infrastructure, especially in Germany. In an early indication of the upturn in industrial activity, German domestic industrial orders accelerated sharply in the last three months of the year.
Inflation continued to moderate and fell to 1.7% in January (based on preliminary data), reflecting lower energy prices and slower services price growth. With moderate growth and lower inflation, the European Central Bank held its benchmark deposit rate unchanged at 2%. Although markets are expecting no changes in monetary policy in 2026, the ECB has not ruled out further cuts should the euro strengthen excessively or the economy weaken.
Donald Trump announced his pick to succeed Jerome Powell at the head of the Fed. Kevin Warsh, a former member of the Federal Reserve Board of Governors (2006–2011), will take over in May, subject to Senate approval.
Kevin Warsh has a record of making price stability a top priority and is sharply critical of the expanding Fed balance sheet. In his view, quantitative easing created inflationary pressures and distorted capital allocation.Yet we think it unlikely that he will immediately take steps to shrink the Fed’s holdings, since any such move would send both short and long rates up, thereby increasing the cost of credit, which would clash with what the Trump administration wants.
More recently, Warsh has adopted a more dovish tone, emphasising that productivity gains from the embrace of AI and deregulation by the Trump White House will drive inflation down. In his opinion, these forces provide room for the monetary authorities to reduce rates without risking a resurgence of upward pressure on prices.
President Trump’s announcement on 30 January of Kevin Warsh as his pick to lead the Fed has not shifted market expectations of two rate cuts in 2026.
The US economy added just 181,000 jobs in 2025 – far fewer than the 1.2 million previously estimated and the lowest number of jobs created outside recession years since 2003. January, June, August and October even recorded net job losses.
European productivity growth automatically comes out stronger than anticipated against this lacklustre 2025 jobs market in an expanding US economy.
Hiring was stronger in January 2026 as employers added 130,000 jobs. Since these were largely in the healthcare sector (124,000 jobs), talk of a broader recovery in the employment market is premature.
Prime Minister Sanae Takaichi’s gamble paid off. She won a historic victory in a snap election held on 8 February 2026. Her Liberal Democratic Party swept 316 seats out of a total of 465 in the lower house of Japan’s parliament, the first time since World War II that a political party has won a two-thirds majority. In alliance with the Japan Innovation Party, the ruling coalition holds 352 seats. Prime Minister Takaichi has substantial political capital and plenty of room to pursue an expansionary fiscal policy – with plans to introduce a temporary reduction in food taxes and increase military spending – while reassuring the markets that she will maintain fiscal credibility to avoid a surge in long-term interest rates.
Bucking the trend in major central banks in mature economies, the Japanese monetary authorities are expected to continue their normalisation policy. Markets are pricing in two rate hikes of 0.25% in 2026.
As geopolitical tensions ease, more microeconomic fears have moved centre stage in the markets, leading to large-scale sector rotation.
The result is a big performance gap. Tech, communication services and discretionary consumption stocks (which include Amazon and Tesla) all fell since the start of the year, while more defensive sectors, like consumer staples and healthcare, and cyclical sectors, including materials and energy, outperformed.
Two major concerns have emerged as triggering this rotation:
Although not new, the first (high spending on AI) has intensified in response to announcements of massive increases in capital expenditure by hyperscalers. Following the publication of their quarterly results, Google, Microsoft, Amazon and Meta Platforms all significantly raised their capex forecasts for 2026. Together, they expect to spend US$660 billion annually, which is more than 2% of US GDP. This high capital intensity will automatically reduce their ability to generate cash flow. Investors are concerned about the potentially dilutive impact of these investments on the groups’ profitability.
The second major catalyst is more recent. AI is set to disrupt a swathe of industries. Anthropic’s recent launch of Claude Cowork, an agentic AI assistant that allows users to automate complex office tasks without the need for coding skills, has accelerated the correction in software stocks (around 20% since the beginning of the year). The market fears that this type of application poses an existential threat to a large number of specialised software programmes.
While this indiscriminate reaction may seem excessive, it nevertheless illustrates the intrinsic vulnerability of these business models in the face of constantly evolving AI applications. In addition, the very stretched valuations in the sector offer little protection to investors in an unpredictable environment with reduced visibility.
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