MFS sees broader diversification as risks reshape markets

MFS Investment Management has outlined eight themes it believes will shape markets in the second half of 2026. Its outlook argues for broader diversification as concentration in US equities and pressure in private credit reshape portfolio risks.

The investment manager's Market Insights Team said investors were entering a period marked by AI disruption, supply-side inflation pressure, weaker confidence in the US dollar and a widening gap between public and private credit markets. Throughout the paper, it emphasised selectivity over broad market exposure as the main response.

One of the clearest messages was that the recent dominance of a small group of US technology stocks may give way to broader participation. Returns in US large caps have been driven heavily by mega-cap technology names, but improving earnings prospects outside the US and stronger performance from smaller and mid-sized companies suggest a wider rally could develop.

That view extends beyond the US. Europe, Japan and emerging markets were highlighted as regions where valuations remain more attractive and where economic and corporate drivers differ from those in the US. Global exposure, the paper argued, can serve not only as a hedge against concentrated US equity positions, but also as a way to access different earnings trends and currencies.

Fixed income also featured prominently in the diversification case. High-quality global credit and emerging market sovereign debt could help strengthen portfolio resilience, with corporate fundamentals and free cash flow still supportive for investment-grade issuers despite geopolitical uncertainty.

Security spending

The report also pointed to a structural increase in defence and security spending. Every NATO member had met the alliance's 2% of GDP target for defence spending, while Europe and Japan had both increased military budgets.

MFS argued that this spending cycle extends beyond conventional defence procurement. Energy, critical minerals and supply chains are now part of a broader security framework, especially after recent restrictions on exports of strategic materials exposed vulnerabilities in global supply networks.

That shift has direct consequences for investors because such spending is usually financed through deficits and new debt issuance. The result is likely to be modest support for growth alongside upward pressure on inflation and bond yields, creating opportunities in sectors governments now regard as strategically important.

AI effects

Artificial intelligence was another dominant theme, though MFS took a cautious view of how investors should approach it. Rather than treating AI as a simple sector bet, the firm said the key question was whether companies could turn the technology into stronger economics through proprietary data, customer relationships, pricing power and control of critical workflows.

It warned that AI could just as easily destroy value for companies exposed to automation, commoditisation and margin pressure. That makes valuation discipline important because enthusiasm for obvious beneficiaries can leave other potential winners overlooked while pushing richly valued stocks to levels that already assume near-perfect execution.

The AI investment cycle is also spreading well beyond the largest cloud and software groups. The report identified semiconductor makers, utilities, power infrastructure businesses and selected industrial companies as likely beneficiaries of the buildout of data centres and related systems.

Yet MFS drew a distinction between the equity and credit implications of that spending wave. In equities, it supports a broader range of sectors. In credit, the concern is who funds the expansion and on what terms, especially if debt issuance rises faster than investor demand.

Cost pressure

Another theme was the return of supply-side constraints. Labour shortages, high energy costs and years of underinvestment in infrastructure are keeping production costs elevated even as overall demand cools.

That could make inflation more persistent and squeeze margins for companies that cannot pass on higher costs. The backdrop is likely to increase dispersion between businesses with pricing power and those operating in highly competitive or commoditised markets, making stock selection more important.

This fed into the firm's support for a growth-at-a-reasonable-price approach. Investors should focus on companies with durable earnings, solid balance sheets and management teams able to adapt to changing competitive conditions, rather than relying on narrow market leadership or expensive cyclical winners.

Dollar and credit

On currencies, MFS said the dollar remained dominant in the global financial system but was slowly losing ground as a store of value. It argued that tariffs, sanctions, fiscal pressures and broader doubts about US exceptionalism were prompting central banks and investors to look more closely at non-dollar assets, including gold, emerging market currencies and local debt.

The paper's final warning centred on private credit. MFS said the asset class was undergoing its first meaningful stress test after years of rapid expansion, with wider spreads, higher non-accruals and a shrinking illiquidity premium changing the risk-reward balance.

While the pressure in private credit is unlikely to trigger a broader economic shock, the repricing has restored the appeal of public fixed income because liquid credit markets still offer attractive yields and more flexibility. Liquidity, the report argued, has become a core part of risk management as investors face a more complex mix of geopolitical, inflation and funding risks.

Private credit still has a role in diversified portfolios, but allocations should be carefully calibrated to reflect a risk profile that has materially repriced.