With fiscal pressures intensifying, the risk of relying solely on traditional stock–bond correlations for diversification has never been higher, according to State Street Investment Management.
The firm’s 2026 Global Market Outlook (GMO) notes that investors are increasingly turning to alternative asset classes designed to act as deliberate stabilisers, helping portfolios withstand volatility and a growing set of macroeconomic, policy and geopolitical risks.
“In today’s more divergent macro landscape, the imperative for alternatives is broader: portfolios must be built to withstand not just volatility, but also regime shifts. Investors need exposures that deliver sustainable income, provide genuine diversification, and give access to growth themes that are reshaping the global economy,” the report said.
Investor appetite for alternatives has climbed in recent years as confidence in the traditional 60/40 stock-bond mix has waned. Private equity, private credit, gold and select hedge fund strategies are expected to play a larger role in the coming year, providing structural diversification to the classic portfolio model. These assets, the firm says, are generally less correlated with conventional equities and bonds and tend to be influenced by secular themes, regulatory changes and regional market conditions.
“Gold, in particular, has proved a powerful diversifier, benefiting from both structural and cyclical tailwinds. Central bank purchases provide price-inelastic demand, while geopolitical tensions, fiscal imbalances, and lingering inflationary concerns reinforce gold’s appeal as a strategic hedge. Its low correlation with equities and resilience in times of uncertainty make it an essential component for portfolio diversification,” the report said.
State Street Investment Management adds that discretionary macro, equity hedge and risk-parity strategies also strengthen diversification.
“Skilled managers can profit from geopolitical shifts, currency moves, and commodity price changes, while risk parity approaches balance exposures across asset classes, mitigating risks from market concentration and regime shifts.”
The firm emphasises that alternatives are increasingly central not just to managing risk and generating income but also to capturing growth in an environment where traditional drivers are under strain.
Digital infrastructure is highlighted as a key growth theme for 2026, fuelled by rapid AI adoption and ongoing cloud expansion, which are expected to drive strong demand for data centre development. But the firm cautions that discipline is essential in a sector attracting significant attention and prone to periods of overheating.
“Infrastructure is not only a source of stable income but also a driver of long-term capital appreciation as economies modernise.”
Caution on Aussie equities
The global economy – and the US in particular – is expected to expand further in 2026, though State Street says this growth continues to be accompanied by a sense of caution.
“With most of the easing cycle globally behind us, and as central banks move closer to assumed neutral rates, we are now more cautious about the pace of future rate reductions, and expect more divergence between central banks,” the report said.
Jonathan Shead, head of investments for Australia, added: “The RBA remains more focused on managing inflation and less on the softening labour market justifying its cautious stance. While markets have interpreted that as expecting no further cuts, a material deterioration in employment could prompt a policy pivot toward accommodation. While we do not expect a material deterioration, we cannot rule that out and hence caution on entirely pricing out rate cuts. Our view is that this is a pause in the rate cutting cycle rather than necessarily the end.”
Shead said that with the global outlook improving and limited catalysts for further domestic growth, Australian investors should prioritise diversified global portfolios.
“In practice, this means tilting portfolios to have a lower home bias, particularly in equities. We are cautious on Australian equities as valuations and momentum remain unattractive.
“Diversifying across asset classes including Australian fixed income – which we think is attractive at this stage, offering income, capital preservation and diversification – and gold will also help investors deal with the still considerable uncertainty in global markets.”
Private equity strong option in 2026
Private equity is emerging as a major growth avenue for 2026, supported by a marked revival in public listings. IPO activity surged 64.5 per cent through mid-October 2025 compared with 2024, with high-profile floats from Databricks, Klarna and Shein helping sustain momentum.
At the same time, State Street Investment Management says the expansion of private equity secondaries is easing liquidity challenges by enabling investors to buy into established funds at later stages of their lifecycle.
“This approach may mitigate the J-curve effect, reduce ‘blind pool’ risk, and benefit from potentially discounted pricing,” the report said.
Income remains a priority for investors, the firm notes. With bank lending constrained and public fixed income yields under pressure, private credit has expanded to US$2.8 trillion, stepping in to provide flexible financing for middle-market companies and merger and acquisition activity.
“Direct lending and opportunistic strategies have generated attractive total returns relative to public fixed income, and with further Federal Reserve rate cuts expected, the asset class stands out as a robust source of income. Selecting managers with rigourous underwriting and proven track records is essential to navigate credit cycles and avoid idiosyncratic risks.”
Slight preference for US stocks
State Street says AI optimism continues to underpin global equities in 2026, though “policy risks, volatility, and rich valuations call for a selective investment approach.”
The firm remains constructive on equities overall and maintains a slight preference for US stocks.
“Fuelled by transformative AI investment, robust capital spending, and supportive fiscal policies, US equities remain at the forefront of global markets – yet a careful eye on valuation risks is warranted.”
Beyond the headline-grabbing Magnificent 7, AI’s broader role in shaping capital flows, sector leadership and macro momentum is expected to be central in 2026.
“We remain constructive on equities while recognising that market valuations are expensive – and not just in the US. Higher volatility is likely to return at some point, along with the possibility of market adjustments, but these should be short-lived and overall we remain upbeat for 2026.”
The firm also points to signs of improving sentiment for smaller companies: “Signs of a turnaround in small cap fortunes are emerging; small caps historically have outperformed when the economy is improving and monetary policy is easing. US manufacturing activity appears to have stabilized, while anticipated Federal Reserve rate cuts could alleviate financing pressures on companies, small caps in particular.”
Government bonds over credit
In fixed income, State Street favours government bonds over credit across most major economies. “The US and France have attracted most attention but they are not alone: Japan and a handful of European countries remain on the bond vigilantes’ radar. Looking forward, the US Treasury market remains the linchpin for global rates markets for the coming year.”
While the potential for gains in credit appears limited, the firm sees opportunities in emerging market debt, mortgages and structured credit.
With equity markets trading near record highs and concentration within major indices elevated, State Street warns that investors are facing a landscape characterised by expensive risky assets, high equity–bond correlations and heightened tail risks.
“Global economic growth continues, supported by policy shifts, AI investment, and fiscal stimulus. But uncertainty remains amid lingering trade and geopolitical risks, the report said.”
