Data Update 4 for 2026: A Tumultuous Year (2025) for Global Markets!

Global Equity Markets, Country Risk, Currencies & Interest Rates – 2026 Data Update

Key Concepts:

• Globalization Backlash: A shift away from the previously unstoppable force of globalization, driven by factors like the 2008 financial crisis and resulting distrust in institutions.
• Country Risk: The risk associated with investing or doing business in a particular country, stemming from political, economic, and legal factors.
• Currency Invariance: The principle that valuation should not be affected by the currency used, provided inflation adjustments are consistent.
• Mature Market Premium: An adjustment to equity risk premium accounting for sovereign debt risk, particularly relevant post-US ratings downgrade.
• Country Life Cycle: A framework for understanding how a country’s economic characteristics and risk profile evolve over time (Young, Growth, Mature, Decline).

I. Global Equity Market Performance in 2025

2025 was a generally positive year for global equity markets. Returns were analyzed by region, highlighting both best and worst performers. The analysis initially focused on local currency indices, but was then converted to US dollar terms to allow for more comparable analysis, acknowledging that inflation can distort local currency returns.

• Dollar Returns: Converting to US dollar terms revealed that some markets experienced higher returns than indicated by local currency indices due to currency strengthening against the dollar, particularly in Europe.
• India’s Performance: India was the worst-performing market in dollar terms, with a 3.31% return. This was attributed to a combination of a below-average Sensex performance (approximately 8.8%) and depreciation of the Indian Rupee.
• Market Cap Shift: While the US still dominates global equity market capitalization (47% at the end of 2025), its growth accounted for only 38% of the total increase in market cap during the year. Europe and China outperformed expectations relative to their initial market weight, indicating a partial shift away from US dominance.
• Historical Perspective: The speaker notes that for much of the 21st century, a US-only investment strategy has outperformed globally diversified portfolios, contrary to traditional investment advice. However, this period is considered relatively short in stock market history, and international diversification remains sensible, especially given the increasing globalization of US companies’ revenue streams.

II. Understanding Country Risk

Country risk is a critical factor in investment decisions. The speaker identifies four primary drivers:

1. Political Structure: A trade-off exists between democratic and authoritarian regimes. Democracies offer more continuous, albeit frequent, policy changes, while authoritarian regimes provide stability but with the risk of large, discontinuous shifts.
2. Exposure to Violence: Operating in countries experiencing internal or external conflict significantly increases risk.
3. Corruption: Corruption acts as a hidden tax, increasing the cost of doing business. Systemic issues, not just cultural factors, are the root cause.
4. Legal System: A reliable and enforceable legal system is essential for protecting property rights and enforcing contracts.

Country Life Cycle Framework:

The speaker introduced a framework categorizing countries into life cycle stages:

• Young Countries: High growth potential but also high volatility. Governance is crucial.
• Growth Economies: Continued growth, but becoming more stable.
• Mature Economies: Growth levels off, stability increases. Company narratives become more important than government policy.
• Declining Economies: Aging industries and populations lead to stagnation. Nostalgia for past success can drive misguided policies.

III. Assessing Country Risk – Data & Metrics (Early 2026)

Several methods were discussed for assessing country risk:

• Sovereign Ratings: Moody’s, S&P, and Fitch ratings were presented visually. Caveats were noted: ratings primarily reflect default risk, can be biased, and are often slow to react to changing conditions. Good ratings don’t necessarily indicate overall safety due to potential political and regime risks not captured in default assessments.
• Default Spreads: Sovereign ratings can be converted into default spreads, representing the additional yield investors demand for holding a country’s debt. Data was presented for January 1st, 2026, based on government bonds issued in dollars or euros.
• Sovereign CDS Spreads: Credit Default Swap (CDS) spreads provide a more dynamic, market-based measure of default risk. These spreads reacted more quickly to events in countries like Venezuela and Argentina than traditional ratings agencies.
• Equity Risk Premium Adjustment: The speaker detailed a revised methodology for calculating equity risk premiums, incorporating sovereign debt risk. The US downgrade from AAA to Aa1 by Moody’s necessitated subtracting a default spread (23%) from the US Treasury bond rate to arrive at a true risk-free rate. This adjusted risk-free rate was then used to calculate equity risk premiums for other countries, factoring in their respective default spreads and a volatility adjustment (1.52x) to account for the higher risk of equities compared to bonds.

IV. Currencies and Interest Rates – A Nuanced Perspective

The speaker emphasized the importance of distinguishing between currency risk and country risk, noting they often move together but are distinct concepts.

• Local Currency Government Bond Rates: A survey of 10-year government bond rates in local currencies revealed significant variation.
• Inflation as the Key Driver: Differences in interest rates across currencies are primarily driven by inflation. High inflation leads to high interest rates, and vice versa.
• Risk-Free Rate Calculation: A method was presented for estimating risk-free rates in currencies without local currency government bonds, by adding the difference in inflation between the US and the target country to the US risk-free rate.
• Currency Invariance in Valuation: The speaker argued that valuation should be currency-invariant, meaning the value of an asset should not change based on the currency used for analysis, provided inflation adjustments are applied consistently. Inflation impacts both discount rates and cash flows, offsetting each other when valuation is done correctly.
• Pricing Power: Companies with pricing power are better equipped to navigate inflationary environments.

Notable Quote:

“Inflation is value neutral to a company… if they can pass inflation through, they have pricing power.”

Conclusion:

The 2026 data update highlights a shifting global landscape, with a potential move away from US dominance in equity markets and a growing need to consider country risk in investment decisions. The speaker’s framework for understanding country risk, combined with the emphasis on currency invariance and the importance of consistent inflation adjustments, provides a valuable toolkit for investors navigating an increasingly complex global environment. The key takeaway is that while globalization is facing a backlash, interconnectedness remains strong, and a diversified, risk-aware approach is crucial for long-term investment success.