Why this risk will become a bigger headache for markets in 2026

Ian Rees, co-fund manager of Ruffer Investment Company (LSE:RICA), explains why the amount of money being spent on artificial intelligence (AI) development is cause for concern. The AI theme is his biggest reason to be fearful for financial markets in 2026, while his top reason to be cheerful is US tariffs being in the “rear-view mirror” and them not being as “bad [economically], as people thought at the time”.

Other topics covered include how Ruffer’s portfolio fared earlier this year when stock market volatility picked up, and Rees’ view that, after stripping out the Magnificent Seven companies, the entire US stock market is still expensive.

Rees also gives his take on whether owning the market globally in an index fund or exchange-traded fund (ETF) will be a smart move in the years to come.

• Invest with ii: Buy Investment Trusts | Top UK Shares | Open a Trading Account

Kyle Caldwell, funds and investment education editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Ian Rees, co-fund manager of Ruffer Investment Company. Ian, thank you for coming in today.

Ian Rees, co-fund manager Ruffer Investment Company: Thank you, Kyle. It’s good to be here and good to be here in person.

Kyle Caldwell: Ian, to kick off, could you name your biggest reason to be cheerful and your biggest reason to be fearful in 2026 for financial markets?

Ian Rees: I’d probably say that it has been a calendar year of great uncertainty: tariffs, geopolitical tensions, political tensions. Where exactly are we going? Well, if you think about going into 2026, tariffs can be in the rear-view mirror. So, those worries, whether just in terms of uncertainty or the economic impact, maybe aren’t going to be as bad as people had thought at the time.

And, globally, led by the US, but also in Germany and Europe, you’re going to see fiscal easing. So, fiscal stimulus to come, it’s a tailwind for the economy. Also, interest rates are likely to be cut around the world as well. So, you can have that backdrop of falling uncertainty with monetary and fiscal tailwinds. That, on paper, could be a pretty positive environment for risk assets.

If I was to look at the other side of the ledger, what worries us, and maybe I wouldn’t necessarily want to say it’s going to happen in 2026, but it’s something that I can imagine becomes more of a headache for the market in 2026, maybe into 2027, would be when the AI trade, or narrative, moves from investment to required return.

Also, I think the fundamentals of the AI trade are changing and, I would say, for the worse, they are deteriorating. So yes, many of these companies, if not all, are incredibly cash generative. They are great businesses, we’ve seen that over the last decade or so. Much of the original CAPEX (capital expenditure) was internally generated from free cash flow. So, it might not be going back to shareholders, or it might not be invested in other areas, but they’re not having to borrow.

In recent weeks and months, you’ve started to see more leverage come into this investment to fund that next level of huge growth and investment. It’s being increasingly debt financed. There is more debt in the mix than before. I don’t want to say it’s like 1999, 2000, but the shades of circular reference, the sort of vendor financing, you know, you’ll buy from me and I’ll buy a stake in you, that sort of interconnected loop.

I wouldn’t say necessarily that it’s going to end tomorrow or end in six months, but just looking from afar, there’s a lot of hope and expectation here. At the margin, things aren’t as good as they were in terms of the fundamentals, in terms of how it’s being structured, and at some point, these huge cash flows will need to begin to generate revenue.

And I’m not saying it won’t happen. But if I was looking on balance, that is something that would leave me cautious given the size of the AI complex, if you will, in the US and global equity index.

• Unpicking the curveball that’s rocked trusts with 10%-plus yields
• High turnover vs buy and hold: which fund approach is working best?

Kyle Caldwell: You’ve mentioned AI as a potential reason to be fearful in 2026. Are there still opportunities, though, within that theme and does Ruffer have any exposure to companies that are benefiting from AI?

Ian Rees: We always look. We don’t just say, ‘Oh well, look it’s expensive and scary, therefore we don’t look at it’. We own Amazon.com Inc (NASDAQ:AMZN) in the US, a Magnificent Seven company, where we think we’re not having to pay too much for this optionality. If this investment does generate returns, I think there’s a very attractive investment case there.

Where we have, probably, a less fashionable or less well-known AI exposure would be through Alibaba Group Holding Ltd ADR (NYSE:BABA). Now, if you cast your mind back to the beginning of this year with the unveiling of DeepSeek, it showed me one thing, and that’s if Silicon Valley has a rival, it’s coming from China. The tech is seemingly on a par.

[For] the equity valuation, at least at that time, Alibaba was trading on a single digit price-to-earnings ratio. So, you can get, if you like, equivalent AI capability and tech compared to Silicon Valley at this multiple. It was completely out of step, and that’s performed very well this year.

It still trades at a discount to your sort of US tech valuations, and we can discuss whether that will always be the case, should it be, you know, etc. They aren’t necessarily apples for apples comparison, but hopefully that shows you that even though we might be cautious about something, it doesn’t mean that we turn our back on it entirely.

Kyle Caldwell: Looking back on how financial markets performed in 2025, we had that pick-up in stock market volatility earlier in the year, which was primarily due to the potential risks of US tariffs. In that six- to seven-week period when stock market volatility rose and markets fell quite considerably, how did Ruffer Investment Company fare?

Ian Rees: The portfolio performed well. We were positive in April, and particularly during the eye of the storm, around Liberation Day.

When I look at what helped the portfolio, our equities fell like equities around the world. There was no saviour there. What protected us, really, were the derivatives. This is a part of the portfolio that can look quite different to many other managers.

What positions helped us? Well, we had put options on global equity indices. So, as those markets began to fall, those put options were rising in value. We had positions that benefited as volatility in equity markets was rising. So, clearly, as Liberation Day shocked markets, volatility spiked. That was great for those positions.

We also have positions that rise in value if corporate bond spreads widen. To just explain what that means, when corporate issuers issue bonds, they typically pay a premium to the sovereign, some sort of risk premium. In times of difficulty, that premium widens. So, April was a moment where corporate bond spreads widened, that helped the derivatives that we held.

But what is important, and April was a great example of this, is that it basically turned into a V shape, didn’t it? Trump sort of pivoted and markets recovered very sharply.

But because we had taken some profits in those derivatives when they were making a lot of money, it meant that as the market recovered, we were able to monetise, take those profits and we didn’t give them all back as the market recovered. So, we came out of it better than when we went into it.

• Fund Focus: the overlooked trap some investors fall into
• Smithson fund switch: will it pay off, and who are its rivals?

Kyle Caldwell: Since Liberation Day, a strong stock market recovery’s played out, and various stock markets hit record highs, including the US, the UK and Japan. When stock markets hit new peaks, is that a potential cause for concern?

Ian Rees: It depends. The three nations, or the three markets, that you mentioned there are all quite different. In the case of the UK and Japan, it’s taken quite a long time to get back to some of those all-time highs.

When we look at the valuations, we think the UK is attractive, and there are some areas that are very attractive. Japan has performed very strongly if we look back to when Prime Minister Shinzo Abe was elected in 2012, 2013. But a lot of that improvement in Japanese returns has come from earnings. It’s been a fundamental-driven story and bull market.

The US is a more difficult one when I look at it, because it has delivered good earnings growth, particularly coming out of the pandemic, but the multiple, i.e. the valuation that those stocks are trading on, is very high. So, it’s not quite apples for apples saying, well, they’re all- time highs. Some markets are still very good value, and one we think is at the upper end of where the valuation should be.

So, more nervous on the US. I think to really emphasise on US valuations, the Magnificent  Seven, although brilliant tech companies, they can, in my opinion, be a distraction because NVIDIA Corp (NASDAQ:NVDA), Amazon, Alphabet Inc Class A (NASDAQ:GOOGL), etc, are exceptional global companies that happen to be listed in the US, right?

They trade expensively because they have great fundamentals and high growth prospects, so the market puts them on a pedestal. But what’s interesting with the US is that the remaining 490 or 493 are also very expensive.

It’s not that you have expensive great companies and then cheap companies. You have expensive and then the rest are also quite expensive too. You don’t have particularly wide or high valuation dispersion. And that, to us, is really why a lot of our equity exposure is outside the US. There will always be opportunities, don’t get me wrong. But there’s not an abundant supply of great ideas, in our opinion, in the US at the moment.

Kyle Caldwell: You’ve mentioned concerns about valuations across the entire US stock market and not just the so-called Magnificent Seven. Of course, if an investor has exposure to a global index fund or a global exchange-traded (ETF), then they will have a lot of US equity exposure, typically around 70%. This has proved to be a smart trade over the past five, 10, 15 years. Going forward, do you think it won’t be as smart a move to own the market globally?

Ian Rees: I think so. Really, the key is always the starting point. If there’s one thing that you can control in investment, it’s the price you pay. Where did you start from? Today, the US, as you say, is about 70% of a global index and those valuations and margins are high. So, if I could choose from my starting point, it probably wouldn’t be here.

But if I break down why I’m more cautious, the last 15, 20 years, it’s been a pretty flat and dry wicket. You know, own equities, buy every dip, be passively invested. It’s been fine because it’s been a rising tide and you’ve had tailwinds, low interest rates, a sort of disinflationary world, which has been a fantastic backdrop for risk assets.

Now, if I look forward, I’m not saying that global equities are going to underperform every year. I’m not saying the US is going to underperform every year. But we think we’re going into a world of higher inflation and a more volatile macro backdrop, such that those trends, which were pretty consistent for a long time, are unlikely to repeat.

So, if you think back to the cricket analogy, there’s more green, it’s swinging around, it’s bouncing. Just having a single holding through that might be much more volatile than people expect. Then, if you add on any disappointment from AI and how the market is currently positioned, it could be a tricky backdrop.

The way I look forward into the world is that you probably need to think about diversifiers in a different way. Bond/equity correlation, we fear, will be positive more often than not. It had been negative. So, you could own bonds and equities and have that natural offset.

So, if they’re positively correlated going forward, what could I have alongside my equities to protect me in an equity market drawdown? That’s where we think our approach can be very complementary to equities, in providing you that offset in those difficult periods. So, you don’t need to worry necessarily as much about your portfolio as if you’re solely invested in equities.

• Watch out: ARK Invest’s Cathie Wood: why we’re betting big on Tesla
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Kyle Caldwell: Finally, Ian, a question we ask all fund managers we interview, do you personally invest in Ruffer Investment Company?

Ian Rees: So, Ruffer is a single strategy asset manager. I own units of two of our open-ended vehicles, which we manage, and so does my son. Ruffer is structured as a private partnership that aligns the longer-term interests of our investors and us as owners of the firm.

Kyle Caldwell: Ian, thank you for your time today.

Ian Rees: Thanks Kyle, thank you for having me.

Kyle Caldwell: So, that’s it for the latest Insider Interview. I hope you’ve enjoyed it. For more videos in the series, do hit the subscribe button and hopefully I’ll see you again next time.