It’s January – the time when we tally up how our investments fared for the previous year and think about what the coming year will bring. I’ve traditionally remarked that I feel no pressure to offer up any kind of forecasts – we’ll leave that for the “sell-side” analysts and strategists from all the big banks and brokerages. (Hint – take the current stock market level and add 8 to 12% – that always seems to be the forecast.)
Instead of offering any real insights into what might happen this year, I’m more interested in reflecting on the current financial landscape as we progress into 2026. Let’s dig in…
Valuations
Okay, valuations… What can we say about valuations…
If you’ve followed our commentary for any length of time, you will know that valuations are the centrepiece of our market outlook. As I’ve been saying for some time, we’re in a very special period in financial history – something many people (especially younger investors) have great difficulty understanding.
The U.S. markets represent around half of global stock market capitalisation – that’s up from less than 30% prior to the GFC (2007). There’s varying reasons this has occurred, but the key message is U.S. markets are as important from a global standpoint as they have ever been. What’s the old saying? When the U.S. sneezes the world catches a cold.
Valuations have been creeping higher since the last cyclical low hit after the global financial crisis. Call it 2010. That’s over 15 years… It’s a long time. A long, long time. It means that if you’re under about 35 years of age, you’ve only witnessed brief periods of “valuation compression”. Instead, “valuation expansion” has had your back.
Valuations have worked their way to a point where they are at historically-extreme levels. There are all kinds of reliable metrics we can cite as evidence of this. Today, for something different, here’s an observation made by the team at GMO.
In a recent note, they made this observation about the number of U.S. stocks that are trading at a price-to-sales ratio of greater than 10 times:
I’m reminded of that legendary quote from Scott McNealy, the former head of Sun Microsystems. In an interview after the dot-com bubble burst he had the following to say:
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
We know how this story ends. The same as it has throughout history. At some point valuations stop expanding and instead deflate back towards some form of “historically-average”. That’s the market cycle. That’s always been the market cycle and always will be the market cycle.
Crowded trades
To offer some insight as to why valuations have been expanding, let’s examine some of the products and strategies investors are flocking to.
It’s been well documented for a while now that passive investing strategies are dominating. This helps explain why the market is becoming increasingly dominated around a small cohort of big companies.
As an example, prior to Christmas I received an email from BetaShares – the prominent “exchange-traded fund” manager. Reporting on the year that was, they noted that their “smart beta” funds were some of their most popular.
If you’re not familiar with the “smart beta” strategy, allow me to give you the quick rundown…
“Beta” measures an investment’s volatility and systematic risk relative to “the market”. In essence, it is an investment’s correlation to the market.
The market thus has a beta of 1.
Say you assembled a portfolio of U.S. stocks that tracked the S&P 500 almost precisely. Your portfolio would have a beta of 1.
Importantly, it is not necessarily desirable to have the highest beta possible. Having a beta of 2 doesn’t mean you will generate a superior return relative to the market. If your portfolio has a beta of 2 and the market goes up 10%, it’s true that you would expect a return of 20% – double the market. But if the market goes down 10%, you would expect a loss of 20%!
Now, the premise of “active management” is to try and “beat the market” – to generate what’s described as “alpha”.
There’s all different kinds of strategies an investment manager might try in order to generate alpha. One of the simplest and most logical is to own stocks that perform better than the market – simple!
Along these lines, a recent fad in funds management land has been “factor investing”. Factor investing involves categorising individual shares based on persistent observable characteristics. Common “factors” include “growth”, “value”, “quality”, “momentum”, “size” and “market-cap”. The portfolio manager will then allocate capital to specific “factors” on the basis that they have been outperforming the broader market.
“Smart beta” typically puts a “factor investing” overlay to a standard “passive”, market-following strategy.
As an example, a U.S. markets smart beta fund might use the S&P 500 as their benchmark and broadly assemble their portfolio to track it. But in an attempt to add “alpha”, they weight the fund investments using factor investing principles by having a greater allocation towards some specific areas.
Of course, in order to out-perform, they need to have higher exposure to “what’s working”.
Do you see where this is going?
Without looking, I’m willing to guess that many “smart beta” funds currently have an oversized weighting to “growth” – aka “big tech”. That’s what’s been working. There’s no point having an outsized weighting to factors that are underperforming, such as “value” – that will only detract from the benchmark “market return”.
My expectation is virtually none of these “smart beta” funds will generate superior returns over the long-term. That’s because, over a full market cycle, “what’s working” changes. If “value” begins to handsomely out-perform “growth”, you need to change your weightings. But it will take time to decide that there’s been a durable change in “what’s working”, during which time your portfolio has underperformed the market.
This brings us to our first “positive” as we roll into 2026. Positive momentum.
The share market has a natural “bid” under it. As an illustration, a bunch of Aussies receive a big wad of super contributions from their employers. They add to their holding of BetsShares “smart beta” ETF’s. This induces BetaShares to buy more of “what’s working”. This sort of thing is happening on a global scale.
There’s also the effect of share buybacks, which also puts a natural bid under a lot of U.S. stocks.
Yawn
What can we say about the current economic backdrop, particularly in the U.S.? Growth is weak, but it is positive. Inflation remains quite “sticky”, but recent data doesn’t seem to suggest it’s about to accelerate. Unemployment remains low and recent data suggests the U.S. economy continues to generate enough jobs to keep unemployment low.
The U.S. economy sure isn’t particularly healthy, but it does look quite “stable” in its anaemic state.
That needs to be acknowledged as another “positive” as we roll into 2026.
Looking further out, much has been said about the composition of growth – the “two-speed economy”… the “K-shaped economy”…
The economy is being propped up by large government budget deficits and tech-sector investing.
The U.S. federal government ran a deficit of US$1.8 trillion in 2025. That was actually slightly down compared to 2024.
Around 6% of GDP:
It’s true that the US has run a deficit for most of the last 100 years – it’s nothing new. But three important observations can be made about right now:
Firstly, note that elevated deficits have generally been associated with periods of recession – that’s when tax receipts decline and unemployment claims increase. The current size of the deficit is striking considering that the economy is “relatively healthy”.
Related to this, it’s important to realise where so much of this money is going. The massive deficits haven’t been to fund valuable nation-building projects. They haven’t got another Hoover Dam or interstate highway network. Instead, a large component of the deficit can be traced to citizens that can’t afford to get by in modern-day America. Spiralling healthcare costs, Social Security and welfare payments.
And if you follow the accounting entries through, you will discover that the government deficit is a major driver of corporate profits. A “deficit” in one sector mirrors a “surplus” in others.
The final observation is the size of accumulated debt. It’s a problem. Part of the problem is the fact that interest payments on the outstanding debt are a significant contributor to the deficit.
A lot of smart people are envisaging a debt crisis to unfold in the coming years. Certainly not this year or even next year. But what can’t continue won’t continue and there’s a point where it stops. We’ve reached this point of “fiscal dominance” – where the size of the government debt and deficit are having a major influence on the Fed’s monetary policy options and “crowding out” the private sector.
In terms of that other driver of economic activity – tech spending – this will taper off quite soon. Referring back to our comments from recent months, most of the capital being spent on data centres and other “AI” stuff will be incinerated. Depreciation will exceed revenues generated.
At all costs
It’s now widely acknowledged that the U.S. economy has become very reliant on the wealthy for economic activity. All this tech spending and the associated asset bubbles in stocks, private equity and private credit have become a key feature of the U.S. economy – feeding the incomes of the wealthy.
It follows that there’s going to be significant political pressure from the Trump White House to keep the good times rolling. Can they do it? Are they more powerful than the market? I think we’re going to find out over the next couple of years.
In summary…
This is certainly not an exhaustive summary of all the macro factors needing our attention, but it captures the big themes as we move into 2026.
Stocks at extreme valuations
Buoyant investor sentiment and positive momentum
A stable – yet fragile – U.S. economy, being driven by unsustainable spending
Strong corporate profits being driven by those same unsustainable forces
Strong political will to keep it all going…
It’s going to be an interesting year.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
Register your interest in this Fund
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Weighing things up
It’s January – the time when we tally up how our investments fared for the previous year and think about what the coming year will bring. I’ve traditionally remarked that I feel no pressure to offer up any kind of forecasts – we’ll leave that for the “sell-side” analysts and strategists from all the big banks and brokerages. (Hint – take the current stock market level and add 8 to 12% – that always seems to be the forecast.)
Instead of offering any real insights into what might happen this year, I’m more interested in reflecting on the current financial landscape as we progress into 2026. Let’s dig in…
Valuations
Okay, valuations… What can we say about valuations…
If you’ve followed our commentary for any length of time, you will know that valuations are the centrepiece of our market outlook. As I’ve been saying for some time, we’re in a very special period in financial history – something many people (especially younger investors) have great difficulty understanding.
The U.S. markets represent around half of global stock market capitalisation – that’s up from less than 30% prior to the GFC (2007). There’s varying reasons this has occurred, but the key message is U.S. markets are as important from a global standpoint as they have ever been. What’s the old saying? When the U.S. sneezes the world catches a cold.
Valuations have been creeping higher since the last cyclical low hit after the global financial crisis. Call it 2010. That’s over 15 years… It’s a long time. A long, long time. It means that if you’re under about 35 years of age, you’ve only witnessed brief periods of “valuation compression”. Instead, “valuation expansion” has had your back.
Valuations have worked their way to a point where they are at historically-extreme levels. There are all kinds of reliable metrics we can cite as evidence of this. Today, for something different, here’s an observation made by the team at GMO.
In a recent note, they made this observation about the number of U.S. stocks that are trading at a price-to-sales ratio of greater than 10 times:
I’m reminded of that legendary quote from Scott McNealy, the former head of Sun Microsystems. In an interview after the dot-com bubble burst he had the following to say:
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
We know how this story ends. The same as it has throughout history. At some point valuations stop expanding and instead deflate back towards some form of “historically-average”. That’s the market cycle. That’s always been the market cycle and always will be the market cycle.
Crowded trades
To offer some insight as to why valuations have been expanding, let’s examine some of the products and strategies investors are flocking to.
It’s been well documented for a while now that passive investing strategies are dominating. This helps explain why the market is becoming increasingly dominated around a small cohort of big companies.
As an example, prior to Christmas I received an email from BetaShares – the prominent “exchange-traded fund” manager. Reporting on the year that was, they noted that their “smart beta” funds were some of their most popular.
If you’re not familiar with the “smart beta” strategy, allow me to give you the quick rundown…
“Beta” measures an investment’s volatility and systematic risk relative to “the market”. In essence, it is an investment’s correlation to the market.
The market thus has a beta of 1.
Say you assembled a portfolio of U.S. stocks that tracked the S&P 500 almost precisely. Your portfolio would have a beta of 1.
Importantly, it is not necessarily desirable to have the highest beta possible. Having a beta of 2 doesn’t mean you will generate a superior return relative to the market. If your portfolio has a beta of 2 and the market goes up 10%, it’s true that you would expect a return of 20% – double the market. But if the market goes down 10%, you would expect a loss of 20%!
Now, the premise of “active management” is to try and “beat the market” – to generate what’s described as “alpha”.
There’s all different kinds of strategies an investment manager might try in order to generate alpha. One of the simplest and most logical is to own stocks that perform better than the market – simple!
Along these lines, a recent fad in funds management land has been “factor investing”. Factor investing involves categorising individual shares based on persistent observable characteristics. Common “factors” include “growth”, “value”, “quality”, “momentum”, “size” and “market-cap”. The portfolio manager will then allocate capital to specific “factors” on the basis that they have been outperforming the broader market.
“Smart beta” typically puts a “factor investing” overlay to a standard “passive”, market-following strategy.
As an example, a U.S. markets smart beta fund might use the S&P 500 as their benchmark and broadly assemble their portfolio to track it. But in an attempt to add “alpha”, they weight the fund investments using factor investing principles by having a greater allocation towards some specific areas.
Of course, in order to out-perform, they need to have higher exposure to “what’s working”.
Do you see where this is going?
Without looking, I’m willing to guess that many “smart beta” funds currently have an oversized weighting to “growth” – aka “big tech”. That’s what’s been working. There’s no point having an outsized weighting to factors that are underperforming, such as “value” – that will only detract from the benchmark “market return”.
My expectation is virtually none of these “smart beta” funds will generate superior returns over the long-term. That’s because, over a full market cycle, “what’s working” changes. If “value” begins to handsomely out-perform “growth”, you need to change your weightings. But it will take time to decide that there’s been a durable change in “what’s working”, during which time your portfolio has underperformed the market.
This brings us to our first “positive” as we roll into 2026. Positive momentum.
The share market has a natural “bid” under it. As an illustration, a bunch of Aussies receive a big wad of super contributions from their employers. They add to their holding of BetsShares “smart beta” ETF’s. This induces BetaShares to buy more of “what’s working”. This sort of thing is happening on a global scale.
There’s also the effect of share buybacks, which also puts a natural bid under a lot of U.S. stocks.
Yawn
What can we say about the current economic backdrop, particularly in the U.S.? Growth is weak, but it is positive. Inflation remains quite “sticky”, but recent data doesn’t seem to suggest it’s about to accelerate. Unemployment remains low and recent data suggests the U.S. economy continues to generate enough jobs to keep unemployment low.
The U.S. economy sure isn’t particularly healthy, but it does look quite “stable” in its anaemic state.
That needs to be acknowledged as another “positive” as we roll into 2026.
Looking further out, much has been said about the composition of growth – the “two-speed economy”… the “K-shaped economy”…
The economy is being propped up by large government budget deficits and tech-sector investing.
The U.S. federal government ran a deficit of US$1.8 trillion in 2025. That was actually slightly down compared to 2024.
Around 6% of GDP:
It’s true that the US has run a deficit for most of the last 100 years – it’s nothing new. But three important observations can be made about right now:
Firstly, note that elevated deficits have generally been associated with periods of recession – that’s when tax receipts decline and unemployment claims increase. The current size of the deficit is striking considering that the economy is “relatively healthy”.
Related to this, it’s important to realise where so much of this money is going. The massive deficits haven’t been to fund valuable nation-building projects. They haven’t got another Hoover Dam or interstate highway network. Instead, a large component of the deficit can be traced to citizens that can’t afford to get by in modern-day America. Spiralling healthcare costs, Social Security and welfare payments.
And if you follow the accounting entries through, you will discover that the government deficit is a major driver of corporate profits. A “deficit” in one sector mirrors a “surplus” in others.
The final observation is the size of accumulated debt. It’s a problem. Part of the problem is the fact that interest payments on the outstanding debt are a significant contributor to the deficit.
A lot of smart people are envisaging a debt crisis to unfold in the coming years. Certainly not this year or even next year. But what can’t continue won’t continue and there’s a point where it stops. We’ve reached this point of “fiscal dominance” – where the size of the government debt and deficit are having a major influence on the Fed’s monetary policy options and “crowding out” the private sector.
In terms of that other driver of economic activity – tech spending – this will taper off quite soon. Referring back to our comments from recent months, most of the capital being spent on data centres and other “AI” stuff will be incinerated. Depreciation will exceed revenues generated.
At all costs
It’s now widely acknowledged that the U.S. economy has become very reliant on the wealthy for economic activity. All this tech spending and the associated asset bubbles in stocks, private equity and private credit have become a key feature of the U.S. economy – feeding the incomes of the wealthy.
It follows that there’s going to be significant political pressure from the Trump White House to keep the good times rolling. Can they do it? Are they more powerful than the market? I think we’re going to find out over the next couple of years.
In summary…
This is certainly not an exhaustive summary of all the macro factors needing our attention, but it captures the big themes as we move into 2026.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
Register your interest in this Fund
Lorem ipsum dolor sit amet, consectetur adipiscing elit. Ut elit tellus, luctus nec ullamcorper mattis, pulvinar dapibus leo.