Volatility Picks Up—Maintaining Diversified Exposure Remains The Key

The US market volatility as measured by CBOE VIX* has increased by ~43% since start of the year, indicating fear and uncertainty. However, unlike a typical risk-off episode, this phase of volatility has coincided with market broadening, with US small caps outperforming large caps on a YTD basis. Also, investors have become more cognizant of selecting companies with stronger fundamentals and durable moats within the AI space. While conviction in AI’s transformative potential remains intact, segments of the traditional software space are facing pressure, as they are increasingly viewed as less central to the next wave of technological.

1. Rest Of The World, Specifically EMs Continue To Outperform The US- Our thesis of rest of the world continuing to outperform US in 2026 has played out so far as supported by improving fundamentals and currency tailwinds.
2. Liquidity Conditions In The US Have Started To Tighten On The Margin- Liquidity conditions in the US have started to marginally tighten, with reverse repo operations showing a steep decline in the recent months. The question remains, if Fed would be pre-emptive in its policy action or be again late to the party?
3. Capital Rotations Into Defensives & Some Cyclical Sectors Accelerate- Investors while still confident about the long-term potential of AI are now rewarding companies with stronger fundamentals within that space and at the same time trying to diversify exposure to a bigger basket, including small caps cyclicals such as industrials and materials & defensives.
4. The Takaichi Trade, Making Japan Equities Favourable- Sanae Takaichi is all set to amp up fiscal spending with greater emphasis on defence along with curbing costs for household by way of cutting taxes, providing coupons & cash handouts. The policy shift is increasingly favouring equities, while potentially weighing on JPY and JGBs.
5. China’s Anti-Involution Policy: Supportive for Domestic Growth and Global Commodities, Though Global Revival Remains Key China’s anti-involution policy has started to reap benefits with improving industrial profits and gradual stabilization in inflation dynamics. This acts as a strong tailwind for global commodities, although sustained revival in global economy remains a crucial part in this puzzle.
6. India’s Valuation Premium Remains Intact, Sustainable Turnaround In Earnings And Macros Is Crucial- Improving macros, reviving corporate profitability, stable and credible fiscal policy along with finalized trade deal act as a strong tailwind, however higher valuation remain key overhang.

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