S&P 200 Model Portfolio – Active investing must evolve or keep underperforming

Market Cycle

Global markets grind higher into the end of the year in low turnover. The moves were supported by strong passive inflows that helped offset mixed US economic data. Active investing has mainly underperformed in a market where passive investing is driving outperformance through a handful of mega caps. Global passive flows have targeted mega techs in the US and big banks in Australia. You can’t outperform by running with the herd. Active investors need to evolve their strategy or keep underperforming in 2026.

These global passive flows remain heavily concentrated in US mega‑cap technology stocks, driving the sharpest short‑term rebound and pushing market valuations back toward multi‑decade highs. Within the AI sector, competition continues to intensify as major technology firms increasingly encroach on one another’s market share against a backdrop of slowing economic momentum.

Chinese technology companies released another round of AI model upgrades that outperformed several existing offerings, prompting OpenAI to accelerate its release cycle and expand into search to reinforce user engagement. In anticipation of rising competitive pressure, Google launched an advanced Gemini model built on its proprietary AI chips, attracting interest from major industry players such as Meta and Salesforce and shifting attention away from the OpenAI/Nvidia ecosystem. These developments support the view that the AI market may ultimately consolidate around a dominant model, with others playing more specialized roles — a scenario not yet reflected in current market pricing.

US inflation data provided limited clarity, with several rising components treated as flat due to assumptions linked to the government shutdown. Labour market indicators were softer, showing modest job creation and unemployment rising to a four‑year high. In the political sphere, the White House responded with a series of high‑visibility policy announcements and public positioning efforts, while the release of a portion of the redacted Epstein files added further noise to an already charged environment. These dynamics continue to contribute to heightened political tension within the Republican Party.

Macro Cycles

Recent inflation and employment data have strengthened concerns about emerging stagflation in the US, even as the White House maintains an outlook of strong future growth. Since the beginning of the year, expectations for a period of solid expansion and easing prices have been pushed back from the second half of 2025 into the second half of 2026. Public narratives attempting to challenge official economic data are also gaining less traction, with several claims no longer resonating among conservative commentators or lawmakers. A number of Republican figures are signaling they may not contest the upcoming midterms, while betting markets are increasingly pricing in a shift toward Democratic gains. A more immediate pressure point for Republican policymakers is the sharp rise in health‑care costs taking effect from January, alongside another government‑funding negotiation scheduled in the coming month.

In global markets, the bond market has effectively reasserted control over borrowing costs as Japan continues its gradual move back toward more normal interest‑rate settings. The Bank of Japan’s latest increase lifts rates to 0.75%, the highest level since the 1990s. Long‑dated Japanese government bonds are now trading at yields not seen in decades, and markets are signaling the likelihood of further tightening. This is placing strain on the long‑standing Japanese carry trade, creating potential downside risks for US asset valuations. Meanwhile, the Reserve Bank of Australia is also expected to raise rates in the first quarter of 2026.

Data Analytics and AI takeaway

The preferred investment factors continue to remain with inflation, value, dividend yield, profitability and size. The risk weighted outlook continues to favour value and yield over growth in a stretched global markets with rising stagflation worries.

Portfolio Strategy

Signs of strain in the US real economy are becoming more apparent, with unemployment rising to a four‑year high and recent adjustments to inflation measurement complicating the assessment of underlying price pressures. Consumer confidence remains subdued, and broader sentiment indicators have fallen to their weakest levels in decades. With the mid‑term election cycle approaching, the administration has outlined a range of cost‑of‑living initiatives, though concrete implementation has so far been limited. At the same time, divisions within the Republican Party are becoming more visible across issues such as healthcare, immigration, tariffs, the release of the Epstein files, and policy toward Israel.

Globally, central banks are struggling to contain rising borrowing costs, and Japan’s latest rate increase is expected to place additional pressure on long‑standing carry trades. In Australia, the RBA is facing the prospect of another tightening phase in 2026, while the government continues to face scrutiny over immigration settings, even as population growth remains a key driver of economic activity. Against this backdrop, disciplined risk management remains critical, with elevated inflation and higher rates placing sustained pressure on asset valuations. We maintain our strategy of dominant inflation exposures with defensive yield diversification.

S&P 200 Best 10 Model Portfolio

The best performers year to date in the S&P 200 Best 10 are: Regis Resources (ASX: RRL), Vault Minerals (ASX: VAU), Northern Star Resources (ASX: NST) and Telstra (ASX: TLS).

Note: DDA may or may not have made changes to the model holdings since the end of November update. The data driven model portfolios will continue to evolve with the economic and market cycles.