Risk markets seem unstoppable

But beware mean reversion as market peak!

The bid for risk in late November continued into December with equity indexes, excluding Nasdaq, hitting new all-time highs. The high yield market produced another positive month with the ICE BofA Index seeing spreads compress by 11bp on the month to finish at 281bp, coincidentally, spreads also finished 11bp tighter from where they started the year. 

November’s brief bout of volatility was countered with strong seasonal technicals in December. Spreads are now back to levels where we believe further compression is going to be challenging as many bonds already trade at spreads that are historically quite expensive. To us, it looks like 270bp is a resistance level for high yield spreads:

Using ICE/BofA data for the U.S. high yield market which goes back to the start of 1997, no year has had a lower starting spread than 2026. While there appears to be a supportive technical “January effect” where cash is deployed into markets boosting asset prices, we view this as an opportunity to selectively trim risk into strength. We expect robust new issuance driven by attractive spreads for issuers, a need to refinance upcoming maturities and AI driven spending which has seen a steady stream of new issuing entities over the past several months.

High yield returns in 2025 benefitted from both lower government bond yields and tighter spreads but most of the compression in market yields came from the Treasury market, where the key five-year yield dropped from 4.4% to 3.7% over the course of the year. For another similar drop in government yields, we believe that there would need to be significant economic weakness, which would likely result in higher spreads than current levels.

As a base case we would expect the high yield market to generate lower returns in 2026 than 2025 driven by a lower starting yield and limited room for spread compression.

Risks tend to build up over long periods of rising asset prices and low volatility. We believe that valuations that aren’t likely to be backed up by cash flows in coming years are one of the largest sources of risk in markets today. This is particularly true for anything associated with AI, as the narrative of future growth has been the dominant driver rather than results or business models being proven.

In January 2026, Bloomberg reported that Elon Musk’s xAI had successfully raised $20 billion in a Series E funding round, valuing the business at $230 billion, an increase of more than 50% from a funding round in mid-2025. This increase in valuation occurred despite the fact that the business is highly unlikely to meet the 2025 financial projections issued in the middle of last year, with lower revenues and wider losses.

Rising asset prices in the face of subpar results is hardly isolated to venture and private markets. Over the past two years, Tesla’s equity price has roughly doubled, while the consensus estimate for 2026 EBITDA has been cut in half. While this is a particularly extreme example, there are plenty of other companies where equity prices and earnings estimates have moved in opposite directions over the past year.

The circularity of the AI financing ecosystem has continued to grow into 2026. News articles reported that Nvidia contributed as much as $2 billion of the xAI Series E financing, increasing their exposure further by contributing equity capital to a Special Purpose Vehicle (SPV) backed by Valor Equity Partners to buy $5.4 billion of their own chips for xAI’s data centers. While AI infrastructure spending continues to grow, the ultimate business models of the software businesses are largely unproven, while revenue growth looks to be already falling behind lofty expectations for several leading companies.

The dramatic increase in credit markets exposure to the AI data center buildout since September will likely continue to create both volatility and trading opportunities in 2026. While retail investor enthusiasm remains high for many AI-related businesses, there was large insider selling of Coreweave Inc. (NSD: CRWV) on December 24, well below mid-January trading levels of the stock.

Geopolitical risk has been largely brushed aside by markets in recent years, but that could change in 2026. Increasing inequality combined with frustration with the past several years of elevated inflation could result in both a “blue wave” and a rise of populism in the U.S. midterm elections this year which would likely be viewed negatively by markets.

In early 2026, risk markets feel almost unstoppable, but history has shown that markets eventually mean revert, and periods of extremely buoyant sentiment often occur close to market peaks.

Justin Jacobsen, CFA, is the Portfolio Manager of the Pender Alternative Absolute Return Fund at PenderFund Capital Management. Excerpted from the Pender Alternative Absolute Return Fund Manager’s Commentary, December 2025. Used with permission.

Disclaimer

Content © Copyright 2026 by PenderFund Capital Management Ltd. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

Securities mentioned in this article are for illustrative purposes only and do not constitute an investment recommendation. Always consult your financial advisor before investing in any security.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in net asset value and assume reinvestment of all distributions and are net of all management and administrative fees, but do not take into account sales, redemption or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This communication is intended for information purposes only and does not constitute an offer to buy or sell our products or services nor is it intended as investment and/or financial advice on any subject matter and is provided for your information only. Every effort has been made to ensure the accuracy of its contents. Certain of the statements made may contain forward-looking statements, which involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

Image: iStock.com/Paperkites