Investors have reduced their exposure to US equity markets, as noted by BNY economists. Throughout 2025, US portfolio weightings declined from a high of 68% to just above 64%.
Europe experienced its strongest performance in late Q1 and early Q2. This was driven by diversification away from the dollar following ‘Liberation Day’ tariffs. European holdings reached over 11% of portfolios but have since decreased, though they remain above early-year levels, indicating continued support for European reinvestment.
Emerging Markets And FX Gains
As US and Eurozone markets ended the year lower, emerging markets gained traction. This trend is expected to persist into 2026. Increased positioning in these markets is lighter, not necessarily reducing developed market exposure. However, FX gains may be limited due to yield differentials favouring high hedge ratios, and export competitiveness pressures could constrain appreciation potential.
With large investors reducing U.S. equity exposure from 68% to 64% of their portfolios, we believe it is prudent to add downside protection. Buying put options on the S&P 500 or Nasdaq 100 indices for February 2026 expirations could hedge against a potential early-year pullback. This cautious stance is supported by the recent U.S. Q4 preliminary GDP figures, which at 1.9% fell short of the 2.2% consensus and fueled concerns of a slowdown.
We are seeing this uncertainty reflected in the derivatives market, as the VIX has climbed to 17.5 after spending most of Q4 below 15. For traders who believe the market may move sideways or grind lower, selling out-of-the-money call spreads on major US indices could be a viable strategy to generate income. This approach aligns with the observation that investors are using recent strength as a selling opportunity, a trend confirmed by the $15 billion in net outflows from US equity ETFs this month.
In Europe, where holdings have softened from their Q2 peaks, the initial enthusiasm from the post-‘Liberation Day’ tariff reallocation seems to be normalizing. While conviction has lessened, holdings remain above early 2025 levels, suggesting a neutral rather than outright bearish stance. Using collar strategies—buying a protective put and selling a call against a long position—on European indices could lock in some of the year’s gains while forgoing some upside.
Emerging Markets Opportunities
The rotation into emerging markets presents a clear opportunity for the weeks ahead, reminiscent of the 2003-2007 period when a weaker dollar fueled a multi-year EM rally. With positioning still light, we see room for continued momentum into the first quarter of 2026. This view is reinforced by strong Manufacturing PMI data from economies like India, which recently posted a 58.5, contrasting with a US ISM figure that has struggled to stay above 50.
We would consider establishing long positions through call options on broad emerging market ETFs to capture this potential upside with defined risk. However, it is critical to address the currency risk, as yield differentials still favor the dollar. Traders should consider hedging their currency exposure by shorting emerging market currency futures against their long equity positions to isolate the bet on stock performance.
