Investors have endured a testing first half of 2026! We have dealt with Supreme Court rulings, wars, oil shocks, central bank regime changes, and the ongoing artificial intelligence (AI) revolution. Through it all, financial markets look set to close out a surprisingly resilient first half of 2026. In this Special Report, we utilise a scenario-based framework tolay out the key risks and opportunities that are driving our thinking as we map out the second half of 2026 and beyond.
We identify four key scenarios: (1) consolidation and reflation, (2) a disinflationary slowdown, (3) a ‘permanently higher plateau’ for asset prices, and (4) stagflation. Our assessment points to active management, real asset exposure, and high-quality alternatives as key to improving portfolio resilience. We have also progressively trimmed our tactical overweight to equities over recent months, adopting a more balanced stance as we look towards the second half of 2026.
Our key conclusions and guidance to clients:
Stay invested but take some profits on equity holdings and rebalance back towards your strategic asset allocation (SAA).
Take advantage of attractive all-in yields for high-quality fixed income to protect against a disinflationary slowdown.
Consider lifting active manager exposure and manage exposure to well-owned AI names.
Build up exposure to diversifying alternative assets like infrastructure and low beta hedge funds.
Stay nimble and maintain liquidity to respond as the outlook evolves.
Investors across the world have endured a testing first half of 2026! We have dealt with presidential kidnappings, US Supreme Court rulings, wars, oil shocks, inflation, central bank regime changes, and ongoing euphoria/pessimism around the artificial intelligence (AI) revolution. Through it all, and despite some historic intra-period volatility, financial markets have closed out a surprisingly resilient first six months of the year: core global bond yields are broadly flat to slightly higher (and in fact slightly lower in Australia), global equities (as measured by the MSCI All Country World Index) are up around 10% (assuming 50% currency hedging), and the Australian dollar is trading at just under USD 0.70, around 3 per cent higher since the start of the year.
As the northern hemisphere winds down for summer and Australian investors prepare for winter school holidays, we take the opportunity in this Special Report to lay out some of the key risks and opportunities that are driving our thinking as we map out the second half of 2026 and beyond. We do this via a scenario-based framework, which helps clarify narratives and crystallise key portfolio implications. Like soldiers running drills, the goal is to ensure that as investors, we are best prepared to prudently respond to a wide range of probable scenarios and possible tail risks.
A caveat before we proceed – for the sake of brevity, we will limit this analysis to the major risks and catalysts that are most likely to drive the global economy and markets in aggregate. We acknowledge the vast array of regional, idiosyncratic, and company-specific factors that could drive significant dispersion across individual markets or investments. LGT Wealth Management’s internal investment committee considers these, and more, in our monthly deliberations. Indeed, we reviewed our underweight stance on Australian equities, including the top-down and bottom-up considerations driving this, in our recent Special Report.
One final overarching remark: we believe that there are four key aspects to successful scenario analysis. First, lay out a comprehensive yet tractable set of probable scenarios for assessment and planning without overwhelming or confusing stakeholders. Second, prudently assess the likelihood of each scenario to help guide focus and attention. Third, remain alert and prepared for the possibility of tail risks or ‘black swans’ that could upend our carefully laid out thinking. Fourth, determining a set of concrete portfolio implications and/or actions as a result. There’s little point doing all this work if it leads to no action.
With that said, as we look to the second half of an already eventful 2026, we see four key scenarios that we believe capture the bulk of the potential distribution of economic and market outcomes, along with our assessed likelihood of each playing out over the next six to twelve months:
There are a number of potential catalysts that are captured within this scenario. Recent hawkish decisions and messaging from major central banks, including the Reserve Bank of Australia (RBA), European Central Bank (ECB), and US Federal Reserve (Fed), reflect increasing policymaker concerns around inflation and a desire to be more proactive in forestalling an inflationary breakout than they were in 2022. This policymaker tilt will likely pressure equity markets via higher discount rates and a flatter curve. If executed prudently, this could allow markets to rebase, allow US inflation expectations to re-anchor despite a resilient US economy, and provide a ‘healthy’ release of pressure from an overbought market.
We could also see a moderation in AI euphoria, which could again help relieve some market ‘steam’ in the near-term. From a technical market positioning standpoint, we also believe that some period of consolidation within global markets is likely and healthy, to allow investors to digest the historic gains made since mid-March and re-set their positions for the second half of the year.
The likely market implications of this scenario are:
2. Disinflationary slowdown driven by AI euphoria cracking or a central bank policy mistake (~20-30%). This is our key downside scenario with a wide range of potential catalysts and potential market outcomes. On the ‘moderate’ side of things, we could see a traditional central bank policy mistake of overtightening rates that causes a garden variety demand-driven slowdown or recession. Given the underlying health of the US balance sheet (with consumers and the corporate sector in aggregate holding the lowest levels of debt in decades), we would not anticipate this lasting long or imparting significant lasting damage to the global economy or investor portfolios. The traditional response of counter-cyclical fiscal easing (via higher unemployment benefits) and aggressive central bank easing would likely support a recovery in economic conditions in fairly short order.
A far more insidious potential catalyst would involve a near-term bursting of the AI bubble. This is not our base case, and as we lay out further below, we are long-term bulls on the economic and investment benefits that AI will deliver over the next five to 15 years. However, in the near-term, we are seeing nascent signs that could jeopardise global investors’ current ‘all-in euphoria’ on everything AI:
Any of these catalysts could metastasise, putting significant pressure on already-stretched market technicals and investor positioning in AI-related stocks across the value chain, from memory chip makers to large language model (LLM) providers. Furthermore, the rising use of leverage to invest in these names, coupled with the pervasiveness of AI exposure across asset classes (from public equities, private equity, public debt, private debt, and even some real assets), raises the vulnerability of markets to a sudden sentiment shift and downside drawdown.
It is important to stress that this is not our base case, nor should it fundamentally damage prudently diversified long-term portfolios. In addition, the market implications could be quite disperse depending on the catalyst. For example, a moderation in hyperscaler capex could benefit this segment of the AI trade relative to more ‘upstream’ segments such as memory and chipmakers.
Noting the potential historical analogue of the 2001 tech wreck, the likely market implications of this scenario are:
3. A ‘permanently higher plateau’ for financial assets as AI once again disproves the naysayers (~10-20%). Perhaps the infamous words of economist Irving Fisher from 1929 prove true this time around! This represents the obligatory ‘upside risk’ scenario. Though to be fair, markets have lived this scenario over the past 24 months, as the seemingly unstoppable march of AI has overcome various political, geopolitical, and macro headwinds to reward investors handsomely for staying in the market. An important reminder for investors that while we should always prudently consider the downside risks, we also cannot lose sight of the potential upside risks to the outlook!
Indeed, there is much blue-sky potential around the ongoing development and roll-out of AI and other frontier technologies (including biotechnology, genetic engineering, nanotechnology, quantum computing, and nuclear fusion). For example, BlackRock believes that the productivity benefits of AI could boost US trend economic growth by 2.6% per annum or more by 2030, a substantial sum on par with the productivity miracle of the 1990s. Longer term, we agree with this rosy assessment.
Furthermore, it is clear that the frontier large language model (LLM) developers and hyperscalers are targeting more than just the next version of ChatGPT, but are aiming to attain the next revolutionary step in AI. The analogy we use is the petroleum revolution of the 19th and 20th centuries. When we first struck oil in Texas, we burned it for fuel. Over the years, we discovered how to refine it into more specialised chemicals like kerosene, diesel, and asphalt. Then we discovered plastics, a revolutionary invention that created entire new industries from scratch. We view current LLMs as the equivalent of ‘burning’ AI for fuel, and if humanity can successfully achieve the next steps, including human robotics integration, true neural networks, broad-based agentic networks, and other potential uses, the sky could really be the limit!
The likely market implications of this scenario are:
4. Stagflation: US-Iran conflict reignites, sparking a market-relevant downside shock (~10-20%). The key phrase in this scenario is “market-relevant”. Any re-ignition in the US-Iran conflict needs to impart market-relevant downside risks to the outlook for it to be worthy of investor concern. As we wrote in various Special Reports earlier this year, our strong view remains that the constraints on both the US (the bond market and the US voter) and Iran (global consternation and China) are pushing them strongly towards maintaining the current ceasefire and returning to something like the status quo ante of largely free oil flows through the Strait of Hormuz.
Despite headline-grabbing spats and flare ups in recent weeks, these conditions have by and large held true. In addition, oil prices have pulled strongly back from their above USD100 highs despite the doomsday prophecies of USD200/barrel oil. We have long posited that such an eventuality was unlikely due to (1) the flexibility and ability of policymakers to release strategic reserves, utilise alternative pipelines, and relieve pressure on other sanctioned oil to ease supply pressures, (2) the ability of countries worldwide to ‘drill baby drill’ in their own backyards to increase oil supplies, and (3) the destruction of economic demand that would naturally reduce the oil price.
We have also seen the policy playbook if such a scenario were to eventuate: governments would respond to the ‘exogenous shock’ of war by easing fiscal policy via fuel tax breaks or other stimulus, the United Nations would beef up efforts to force the Strait of Hormuz open (as they did in the 1980s), and the material constraints that we have noted would force the belligerents back to the negotiating table. We laid these arguments out in detail in our May 2026 CIO letter. That said, we do have to be wary of other potential geopolitical shocks, including around Cuba and East Asia. In addition, certain regions, like Australia, are already facing stagflation-lite conditions due to internal domestic dynamics.
The likely market implications of this scenario are:
The table below summarises our four key scenarios, including potential opportunities that could benefit investors in each scenario:
Key scenario | Economic backdrop | Likely market and portfolio implications | Potential opportunities |
(~50-60% likelihood) | Around-trend growth and inflation slightly above target | Equity markets consolidate Fixed income delivers decent returns as yields peak Multi-asset portfolios return in line with long-term expectations | Active management adds defence Real assets provide inflation protection Alternatives shield from near-term volatility and access idiosyncratic returns |
(~20-30% likelihood) | Below-trend growth and disinflation | Equity markets fall sharply Fixed income protects portfolios as yields fall Multi-asset portfolios decline but diversifying assets protect relative to equities | Active management adds defence Government bonds (especially long-duration) protect portfolios Foreign currency exposure protects Australian investors as AUD declines Core real assets may protect as discount rates fall |
(~10-20% likelihood) | Above-trend growth and inflation around target | Equity markets grind higher Fixed income delivers decent returns as yields stabilise Multi-asset portfolios return above long-term expectations | Active management and private markets (venture) allow rotation toward next-gen AI beneficiaries Growth real assets allow access to bottleneck thematics (energy transition, resilience, AI, etc) |
(~10-20% likelihood) | Below-trend growth and inflation above target | Equity markets fall Fixed income suffers as yields rise Multi-asset portfolios decline with fixed income not diversifying | Active management adds defence Alternatives shield from near-term volatility and access idiosyncratic returns |
Source: Bloomberg
Through our work, we have identified a number of potential left-field risks to monitor that are not explicitly captured within our four key scenarios, including but not limited to:
Astute readers will notice some recurring themes in the table above, namely that a focus on active management, real assets, and alternative investments should improve portfolio resilience across most or all of these key scenarios. This is not a novel conclusion. Indeed, we wrote extensively in our December 2025 CIO Monthly about these exact portfolio shifts that we have been making in client portfolios over the past year.
To that point, and rounding out the all-important fourth step in successful scenario analysis, (1) we have continued to focus our research efforts on maintaining and enhancing our best-in-class approved product list of active managers, (2) we have pivoted towards real assets and in particular infrastructure opportunities that target bottleneck thematics including AI enablers, energy resilience, and defence, and (3) we have continued to advance the state-of-the-art for implementing truly diversifying alternative exposures in client portfolios.
From a top-down perspective, we have also been actively managing our tactical asset allocation (TAA). Currently, we see an overall picture of moderating but still positive equity market returns, with appreciable tail risks amid stretched markets and concentrated investor positioning. It is still a broadly constructive outlook, and we are not in favour of underweight equity positions on a one-to-two-year timeframe. Yet it is not unequivocally bullish, and as such we have been progressively trimming our tactical overweight to equities over recent months, locking in gains and adopting a more balanced and neutral tactical stance as we look towards the second half of the year.
A final point to make: these scenarios are deliberately studied in a mutually exclusive manner to ensure that we evaluate a wide spectrum of probable outcomes. In reality, the dynamics that we describe in each scenario can certainly interact and co-exist: moderating capex from the hyperscalers could occur alongside a broader AI productivity boom and hawkish central banks! The art and science of effective scenario analysis lies in understanding the disparate outcomes of each scenario as well as their potential interactions, and considering them holistically rather than focusing excessively on any individual scenario.
With that said, the conclusion of our analysis and our overall guidance to clients, whose portfolios have likely drifted overweight equities given the historic rally of the past few months?
Stay nimble and maintain liquidity to respond as the outlook evolves.
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