Portfolio Strategy Report (Q1 2026)

How to keep dancing when the party is slowing down

Ever been to a really good party that you didn’t want to end? Remember that feeling you get when the lights start to come back on, the bar is closing and the music is winding down? There’s a slight wistfulness that the fun is over and it’s time to go home – even if you feel like it’s still a bit too early and want to keep dancing.

That’s exactly how a late-cycle market feels, and we can’t help but draw a comparison with where we are today. The fundamentals are solid and investors are still making money – but valuations are high and there’s tension everywhere. 

Adding to the late-cycle tone is the outlook for the U.S. economy. Growth is expected to be just slightly below trend in 2026 (which we estimate to be around 2.4-2.5%) but will be driven by continued spending on AI-related investments. The contribution from household spending will be mixed as wealth-driven spending is counterbalanced by a slowing labour market and stickier price pressures.

Speaking of the labour market, the rise in the U.S. unemployment rate is what our readers should be eyeing closely in the months ahead. Its climb over the second half of 2025 tells us that the labour market is struggling to accommodate new entrants. The latest reading for the jobless rate is 4.6% for November 2025 – which is still low relative to prior slowdowns – but its continued rise is the main reason we expect the Federal Reserve (Fed) to ease a few more times in 2026.

In Canada, the going expectation is that the economy should continue to ​‘muddle through’ to start the year. Even still, we’re expecting decent years for the financial and materials sectors in Canada. The wildcard? United States – Mexico – Canada Agreement (USMCA) trade negotiations, which should come into sharper focus by Q2. A breakdown could delay planned investments and push unemployment higher — amplifying late-cycle dynamics north of the border.

The key lesson from prior late-cycle regimes is that mistakes matter more when margins for error shrink. While liquidity¹ remains ample, we expect that risk profile will turn more selective. Elevated valuation concerns should persist, shaping several themes we’ve highlighted before:

• Greater reliance on earnings to drive U.S. markets in 2026
• Preference for strong balance sheets and stable earnings
• Continued migration toward international markets that remain relatively cheap (see chart 1)

Chart 1 – Several international markets still look cheap relative to the U.S.

Put simply, the ​‘broadening’ of market leadership will remain an investible theme into the start of 2026. We see this as a natural consequence of increased concentration risk over the past few years and the widespread adoption of technology in other sectors and regions. This is precisely why we’re leaning into quality in the U.S. (which contains increased exposure to healthcare relative to the S&P 500), while emphasizing broader exposure in international markets within our balanced portfolio.

In the tactical space, we expect the global push to develop infrastructure should remain a prominent theme. By extension, this will amplify the supply/​demand imbalance for a few base metals (copper and aluminum) while still supporting gold.

Importantly, late cycle doesn’t mean an imminent drawdown or a repeat of 2022. It does mean that relying solely on the ​“Mag 7” (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, Tesla) is insufficient. In our view, we believe investors should seek markets that haven’t fully participated while adding a layer of defensiveness — especially in the U.S.

That’s how you keep dancing, even as the lights start to change.

Table 1 – Balanced portfolio for Q1 2026

Source: BMO Global Asset Management, as of December 31, 2025. Model portfolio for illustrative purposes only. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. These are not recommendations to buy or sell any particular security. Particular investments and/​or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

* The Annualized Distribution Yield is calculated by taking the most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV. The yield calculation does not include reinvested distributions. Yield calculations for bonds are based on yield to maturity, including coupon payments and any capital gain or loss that the investor will realize by holding the bonds to maturity and. For equities, it is based on the most recent annualized income received divided by the market value of the investments. Please note yields of equities will change from month to month based on market conditions.

Table 2 – Changes to portfolio from Q4 2025

Source: BMO Global Asset Management, as of December 31, 2025. Model portfolio for illustrative purposes only. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. These are not recommendations to buy or sell any particular security. Particular investments and/​or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

Table 3 – Holdings for our updated tax efficient portfolio (Q1 2026)

BMO Global Asset Management. As of December 31, 2025. Model portfolio for illustrative purposes only. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. These are not recommendations to buy or sell any particular security. Particular investments and/​or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

Asset Allocation

• We elected to keep our asset allocation splits consistent with the Q4 edition of our portfolio. Indeed, we remain slightly overweight equities relative to our benchmark (see table 3 below), underweight fixed income and overweight alts/non-traditional hybrids.
• Despite our view that the current market backdrop can be best characterized as ​‘late cycle’, we still feel that an overweight position in equities makes sense. This reflects our conviction that market leadership will continue to broaden from U.S. mega caps to other sectors and regions that are undervalued.
• Our underweight position in fixed income reflects our concern that there is limited scope for both the Bank of Canada (BoC) and Fed to ease rates from here. At the same time, we see risks to duration given term premium spillover from other markets (namely Japan) as well as stickier price pressures in the U.S., which may require a repricing of inflation breakevens.
• We remain overweight alts/non-traditional hybrids as we see this space as a more suitable diversifier for broad equity risk. In particular, we continue to see tailwinds for infrastructure and gold into next year.

Table 4 – Current asset allocation splits relative to benchmark

Source: BMO Global Asset Management, as of December 31, 2025. 

Equities

• In the U.S., we’re increasing our allocation to ZUQ (BMO MSCI USA High Quality Index ETF) as we feel that investors are likely to prioritize strong balance sheets and steady earnings into 2026. Additionally, we like the increased footprint of sectors like healthcare – which remains reasonably valued relative to other sectors.
• For our international allocation, we are broadening our exposure to the EAFE market via ZEA (BMO MSCI EAFE Index ETF) instead of focusing on a particular factor like quality. This reflects our view that international markets have likely decoupled from the U.S. to a degree and that other regions should benefit from a boost in productivity from fiscal spending.
• Additionally, we are making a tactical allocation to ZMT (BMO Equal Weight Global Base Metals Hedged to CAD Index ETF). In our minds, the base metals market should remain strong into the start of 2026 given the balkanized trade environment and the supply/​demand imbalance for certain markets like copper and aluminum.

Fixed Income

• The only notable change we’ve made in the fixed income sleeve of our portfolio is that we’ve swapped out ZUCM.U for ZUAG.F (BMO US Aggregate Bond Index ETF – Hedged). This is to pay tribute to the fact that the Fed has re-started its easing cycle.. 
• We’ve also upgraded this holding to ​‘core’ whilst also reclassifying our holding of ZBI (BMO Canadian Bank Income Index ETF) to ​‘tactical’. The latter is an acknowledgement that we’re likely to begin curbing our position in the quarters to come.

Alts/Non-Traditional Hybrids

• This sleeve has remained relatively unchanged – though we have switched instruments for our exposure to infrastructure. Indeed, we’ve swapped out of ZGI for BGIF (BMO Global Infrastructure Fund ETF – Active ETF Series).
• Put simply, we like the more diversified nature of the latter as opposed to the U.S. specific nature of the former. Also, BGIF focuses on infrastructure areas that we are more constructive on – including electric grids, and engineering/​construction projects. The drawback is the change in cost, though that shouldn’t change the overall cost of our portfolio by much.

Chart 2 – Q1 2026 regional exposure

Chart 3 – Global equity sector breakdown

Table 5 – Fixed income breakdown

Source: BMO Global Asset Management, as of December 30, 2025. For illustrative purposes only.

Table 6 – Performance of holdings over time

Source: BMO Global Asset Management, as of December 31, 2025. The portfolio holdings are subject to change without notice and only represent a percentage of portfolio holdings. They are not recommendations to buy or sell any particular security.

Q1 2026 BMO ETFs fixed income strategy report 

¹ Liquidity: The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price. Cash is considered to be the most liquid asset, while things like fine art or rare books would be relatively illiquid.