In­vest­ment Traffic Lights

1.1  Solid performance overall, but heavy rotation under the surface

We would categorize February as a very mixed month, one where the macro data showed both stronger consumer sentiment from wealth effects, but also a weakening job market, and where AI put the microscope on stocks, savaging sectors that were thought of being ripe for disruption, and rewarding those that were thought to be more immune. February brought along some of the heaviest sector rotations amongst equities seen since the Great Financial Crisis 2007/08 for which the buzzword-frenzy financial professionals quickly coined the acronym “HALO”: heavy assets, low obsolescence. All of a sudden, machinery makers were sexier than asset-light software firms, with the roughly 20% decline of the S&P 500 Software index being the worst 2-month start into the year in history.^[1] On the other hand, the energy sector gained almost a quarter on rising oil prices and materials gained 17%. Another key theme was the U.S. Supreme Court’s ruling on tariffs. It said that the use of the International Emergency Economic Powers Act (IEEPA) to impose broad-based tariffs was unconstitutional, undoing around half the tariffs that President Trump had imposed last year. That saw President Trump announce the imposition of a 10% global tariff instead. We were also interested to read that, for the first time since the Great Depression, more people moved out of the U.S. than in. This may come as no surprise, as the administration is simply delivering on its election promises. However, turning from net positive to net negative migration obviously has implications for many macroeconomic variables such as growth, unemployment and productivity, to name just a few.

As always, the Fed was firmly in focus. The extent, and timing, of cuts was heavily debated as were ongoing issues of independence and an imminent change of leadership. We expect these topics to continue to loom very large over the next several months. Perhaps not unexpectedly, the bond markets watched all this confusion with interest, the yield on the 10-year U.S. Treasury note dropping over the course of the month by more than 30 basis points (bps) to below 4%, its lowest level since October 2024. It seems that, amid the uncertainty, investors were prepared to pay for (perceived) safety.

In Europe, by contrast, we saw relative stability as it appears that the European Central Bank (ECB) has policy levels about right. European stock and bond markets were resilient as one might expect. Bund yields were a little lower across the curve, and major equity indices showed small gains.

In Asia, Japan was the standout. The snap election that the old and new prime minister Takaichi called for early in the month delivered the hoped-for result, and the Bank of Japan continues to normalize policy with inflation behaving – it fell below 2% for the first time since March 2022. Japanese bond markets saw higher yields across the curve as a result, but it wasn’t by enough to spook the stock market which continued its strong run with the Nikkei 225 crossing 59,000 for the first time.

Here at DWS we have recently concluded our latest CIO Day at which our economists, strategists and portfolio managers debate the macro and market environments, and set our views and forecasts for the coming twelve months. Shortly after we did that, we had the news and events in Iran and the wider Middle East. For now, our view is that this won’t necessitate changes to the outlook we forecast, but, of course, that situation remains very fluid, and we are monitoring it closely.

2.1 Fixed Income

This year will be another balancing act for central bankers, particularly in the U.S. At times like these, with the Fed’s two main mandates of unemployment and inflation somewhat at odds, setting policy successfully is very challenging. Add to that the ongoing debates around independence, and a change of leadership at the Fed, and, frankly, we suspect a quiet year – though doubtless hoped for – is unlikely. Inflation is still running above target in the United States and, in other regions, has only recently begun to moderate, leaving the outlook finely balanced. As unemployment shows signs of weakening, central banks face a narrow path and must calibrate policy very carefully to address both upside and downside risks. With most regions cutting, or standing pat, the outlier is Japan where, after decades of low rates, the central bank appears to have finally killed entrenched deflation. If that trend persists, we hope that a generation of central bankers trained to hone in on one problem, are flexible enough to shift to another.

Government Bonds

Our forecast for the U.S. 10-year Treasury yield is 4% by the end of March next year. We call for 3.35% for the 2-year, and 4.75% for the 30-year. We think the U.S. Federal Reserve (the Fed) is still likely to cut twice over the course of the next twelve months, and that these cuts will be driven by a modestly higher unemployment rate (from 4.4% to 4.5% over the course of the year), and an inflation rate that continues to come down. If one looks under the hood of the labor market, then job creation has not been entirely robust across all sectors, and so we think the risk in our forecast is likely skewed to the downside. There’s a chance the Fed may have to cut a touch sooner, or more aggressively, if the labor market weakens.

In Europe we see a year of relative macro, and policy, stability, and leave our forecasts for the Bunds unchanged at 2%, 2.7%, and 3.4% respectively for the 2-, 10-, and 30-year maturities. The three main risks that we see to these forecasts are a change in the situation in Ukraine, a prolonged disruption of energy supply going through the Strait of Hormuz and a sharp move in the euro, but we view these as relatively unlikely.

10-year yields have been grinding lower somewhat

^{Source: Bloomberg Finance L.P., DWS Investment GmbH as of 3/2/26}

Corporate Bonds

In the investment-grade space in both the U.S. and in Europe we recognize that spreads are quite tight by historical standards, but, whilst we remain neutral in the U.S., we think that they could tighten further in Europe. Our twelve-month forecasts are for 85bps in the U.S., and 65bps in Europe. We recognize the AI capital-expenditure (capex) fears that are permeating credit markets globally, but, overall, feel that they are overdone.

Corporate bond spreads showing minor signs of market nervousness

^{Source: Bloomberg Finance L.P., DWS Investment GmbH as of 3/2/26}

In the high-yield space, we forecast some widening of spreads in the U.S. to 325bps, and to 280bps in Europe. In the U.S., our call is based on slightly fragile valuations, low risk premia and potential AI disruption as a headwind for smaller, less flexible credits. Outflows and refinancing risks are noted, but we don’t expect to see a marked spike in defaults. In Europe, we expect some spread widening due to bifurcation – higher quality names should remain tight, but lower-rated sectors (chemicals, software and private-equity deals) are vulnerable. We expect default rates to fall to 2.5-3%, but recoveries may worsen. Our concerns include covenant quality, and private credit standards.

Emerging Markets

We are quite positive on emerging market (EM) sovereign credits, calling for spreads to tighten to around 225bps in one year. Our view is that fundamentals in emerging markets are quite strong, and that we have seen orthodox policies and quite resilient performance despite some ongoing global volatility. We think that this asset class remains a good candidate for diversification, and we forecast strong demand and supportive monetary policy.

Currencies

In currency markets, our view is that recent U.S. dollar weakness (which has paused as a result of the Iran war) continues, but not to the same extent as the last year or so. Contrary to our usual framework for currencies, which revolves around economic fundamentals, our view is that the main drivers of dollar weakness are likely to be sentiment driven and based on U.S. political headlines and subsequent flow. For the EUR/USD we are forecasting a rate of 1.20 in one year, and for USD/JPY we have 145. It’s our belief that policy normalization in Japan, and commensurately attractive higher yields leading to capital repatriation should result in a stronger yen.

2.2 Equities

We believe that there are three very important and powerful trends impacting global equity markets today - dynamism, diversification and disruption. The first refers to the economic backdrop where key top-down factors should stay benign for global equities over the coming 12 months. We expect the Fed to cut policy rates, we expect long-term yields to remain stable, and we believe that several major global economies should expand at their potential with no recession in sight. We’re not saying that the global economy is perfect, or that there aren’t plenty of risks that could upset this relatively sanguine outlook, but, to our thinking, this is a supportive environment for equities. And one in which we expect earnings to grow by double-digits in the U.S., Japan and EM, and by high single-digits in Europe. As such, we stick to our constructive view on stock markets and forecast around a 10%^[2]total return for global equities in the coming year.

The second point, diversification, will be key. If last year taught investors anything, it’s that the U.S. market is no longer the only game in town. Indeed, several of the major international markets, developed and emerging, outperformed the U.S. quite handily. In our view, this trend will continue. The valuation gap that has been growing for years between the U.S. and other markets has shrunk somewhat, but we still think it’s right to be globally diversified - indeed we prefer both Europe and Japan to the U.S. at the moment.  

Finally, disruption from AI has become a dominant theme on global equity markets. Newly announced innovations such as ever better AI models, vibe coding, or the potential for agentic orchestration have called into question the viability of whole business models and raised uncertainty about potential winners. Indeed, the list of perceived AI losers is growing by the day. In particular, the shares of the enterprise software sector have been hit severely. We have downgraded the software sector in late January to neutral. Our thinking was that the arrival of new AI-native competitors and the transition from recurring Software-as-a-Service revenues towards more cyclical sales streams will require a reassessment of the sector. Nevertheless, we are still actively screening the sector for ideas that we think have been oversold. Disruption can also bring opportunity in our view.

U.S. Market

Our one-year forecast for the S&P 500 is 7,500. Our rationale is the benign economic environment we described above, coupled with still robust earnings growth, and yet more AI capex. We expect the valuation multiple in the U.S. to drop from its heady recent highs, and therefore the gap between the U.S. and international markets to narrow, but that still leaves us as constructive on the American market. Of course there are several risks to this view, not least the midterm elections due later this year, and a change of leadership at the Fed. We will also be watching closely for any signs of margin erosion, or deterioration in the earnings quality of large-cap tech firms. 

European Market

We also remain constructive on Europe. We expect to see decent growth this year both in the wider economy and in corporate earnings, where we think mid-single-digit numbers are likely. The slightly stronger euro that we are forecasting could be a small headwind (recall that a stronger domestic currency lessens the benefit of overseas earnings) but by no means a showstopper. Within Europe we prefer small caps and Germany, but overall Europe should also benefit from the diversification trend we think will continue to play out. The region is, and rightly so in our view, seen as a value play with a higher proportion of old economy sectors, areas that mesh nicely with the tech heavy U.S. This outlook (as well as the one for emerging markets) would be at risk, however, should the war in Iran lead to more sustainable price increases in oil and gas. 

German Market

Sentiment continues to improve with Germany. The removal of the debt brake and the fiscal boost are real, and there is growing optimism that German corporates could capitalize on this profound shift in macro policy. A combination of a more business-friendly government, wage growth stoking some consumer spending and still relatively cheap valuations make Germany a bright spot in our view. That said, we prefer a nuanced approach - such as to barbell into higher growth and more profitable companies with attractive earnings recovery potential and strong balance sheets, and, at the same time, stay underexposed to sectors with structural issues and weaker balance sheets. 

Emerging Markets

Overall, the emerging markets have had a stellar run, and we continue to be quite positive on them given the further potential for a rotation out of the U.S. That said, we think that investors may need to be selective. Much of the performance has come from the earnings performance of one or two very dominant firms in South Korea and Taiwan. Whilst we think that could continue, bolstering the region as whole, we would still like to see more sustained earnings growth from China to round out the call and make it less dependent on a small number of firms and regions.

Japan

Japan remains a bright spot in our view. The economy continues to strengthen, and the nascent signs of inflation and wage growth should lead to further policy normalization, though this will be a tricky act for policymakers who are more accustomed to a decades long fight with deflation. We are forecasting low double-digit earnings growth driven by the Financials and IT sectors. As with Europe, our call for a slightly stronger yen could be a headwind, but we think that the stable government, and continued pro-business reforms, with their focus on corporate governance and shareholder returns should win out.   

A European start into the year; at least until end of February

^{Source: Bloomberg Finance L.P., DWS Investment GmbH as of 3/2/26}

2.3 Alternatives

Real Estate

The outlook for listed commercial real estate remains steady in our view as interest rate volatility has been offset by tighter credit spreads. This appears to have unlocked the transaction market and price discovery. Sector fundamentals are slowly improving, with lower supply potentially providing a favorable outlook for 2026. We still favor Europe over Asia and the U.S., and prefer the Industrial, Hotels, Data Centre, Specialty and Retail sectors. In unlisted Real Estate, structural supply shortages and elevated construction costs are supporting rents, particularly for modern stock. In addition, investor confidence and transaction activity are improving, with global volumes rising year-on-year. The U.S. remains resilient, with residential and industrial fundamentals strong. The retail sector is recovering, but office performance remains mixed. Overall, our view is that still tight supply and improving financing conditions support our constructive outlook for the next year.

Infrastructure

Despite a challenging macro environment of high rates, tariff uncertainty and longer transaction timelines, infrastructure has held up quite well. And this is one of the key benefits of its place in the portfolio - its relative insulation from inflation given its passthrough traits and its ability to generate often stable and uncorrelated income. Our forecast for lower interest rates and a more settled economic policy, combined with higher levels of investment in Europe and continued AI capex in the U.S. leave us optimistic on the infrastructure sector. We are particularly positive towards cyclical assets, namely transportation and waste, and we remain positive on the electrification and increasing power demand theme. We expect infrastructure companies in these sectors to generate above-average earnings and cash-flow growth.

Gold

We remain constructive on gold, and, despite its stellar run in the last couple of years, we believe it can go further and could trade at around $5,400 per troy ounce in a year’s time. Our reasoning is that the three main supportive factors that have been in place remain so. The first is central-bank buying at currently 250 tons per quarter, which we think puts a floor on the price at around $4,800. The second is our expectation of money supply growing this year, given that we have found a meaningful relationship between increasing liquidity, which ultimately needs to find a home, and the gold price. Finally, a still easing and accommodative Fed. With more cuts expected this year, lower rates and a potentially weaker dollar should lower the opportunity cost to hold the yellow metal and could make it more attractive to non-dollar buyers. The run up has spurred investors’ interest, and demand, and we believe this has further to go. The war in Iran has led to the gold price reaching our target much faster than anticipated.  

Oil

Our forecast for the Brent oil price is $65 per barrel in one year, and, as always, we base this on the three key considerations for energy – supply, demand and geopolitics. Pre-Iran, our reasoning has been: The first two we view as ending up over the course of the year in a relatively balanced state, hence our forecast for quite a small price move. But we think they will get there in different ways with robust supply early on from Brazil and Norway leading to a surplus of 2 million barrels per day in the first quarter, petering out later in the year to around 500,000 barrels per day. This contrasts with the demand side which we forecast to be relatively steady throughout the course of the year. We have now seen, however, how fast geopolitical shocks can change the equation.  With the fast escalation of the Iran conflict, including the de-facto blockage of the Strait of Hormuz, supply is hampered in the short term. Given the structural imbalances described above and given the vast national stockpiles in oil that especially China has built up, the effect on prices might not be lasting, however. But the situation remains fluid and we will be ready to adapt our outlook if necessary.

Two beneficiaries of geographical stress and debt sustainability worries: gold and oil

^{Source: Bloomberg Finance L.P., DWS Investment GmbH as of 3/2/26}