At the beginning of the year, many investors were expecting stronger growth, lower inflation, and additional interest-rate cuts. Six months later, that picture has shifted considerably.

Inflation has proven more persistent than expected, while central banks have less flexibility than markets anticipated at the end of 2025. Yet equity markets and corporate bonds continue to trade at elevated valuation levels.

«The market is betting that we will return to the environment investors expected at the start of the year,» Lotfi Karoui, Managing Director and Multi-Asset Credit Strategist at Pimco, said. From an asset-allocation perspective, this argues for greater selectivity and a stronger focus on potential downside scenarios.

Corporate bonds remain surprisingly resilient

At first glance, corporate bonds appear expensive. Credit spreads are close to historical lows.

At the same time, however, bonds continue to offer attractive yields. While risk premiums are tight, absolute yields remain significantly above the levels seen during much of the past decade.

More importantly, fundamentals remain supportive.

Despite elevated inflation and the most aggressive rate-hiking cycle since the 1980s, companies have stabilized their balance sheets remarkably well.

«In my view, there is no disconnect between tight spreads and the reality of corporate fundamentals,» Karoui said.

Across both the United States and Europe, leverage ratios, interest-coverage metrics, and profit margins remain healthy. European companies in particular have behaved more conservatively from a bondholder’s perspective than many of their U.S. counterparts.

AI investment fuels debate

One key topic remains the financing of massive artificial-intelligence investments.

According to market estimates, large technology companies are expected to invest roughly $1.5 trillion in AI infrastructure during 2026 and 2027 alone.

An increasing share of these investments is being financed through capital markets.

Even so, Karoui sees no parallels to the technology bubble of the late 1990s.

«The technology sector is currently the least leveraged sector within the non-financial investment-grade universe,» he said.

While debt levels among the so-called hyperscalers are rising, they are doing so from exceptionally low starting points. At the same time, these companies continue to generate extraordinary margins and strong cash flows.

Private credit is losing part of its edge

Karoui is less optimistic about private credit.

Direct lending in particular has experienced explosive growth over the past decade. Assets under management in Europe have increased from roughly €50 billion in 2015 to more than €350 billion today.

That growth, however, has come with side effects.

«There is too much capital chasing too few attractive borrowers,» he said.

The result is lower lending margins, weaker underwriting standards, and increased bargaining power for borrowers.

Recent data also points to early signs of stress among borrowers. At the same time, overlap across many managers’ portfolios is increasing, reducing diversification benefits.

The biggest issue: Price discovery

Karoui is particularly critical of valuation practices across many private-credit funds.

Because loans are not traded regularly, there is often no clear market price. As a result, valuation differences for identical assets can be substantial.

«The most optimistic manager is currently valuing the same loan more than seven points higher than the most pessimistic manager,» he said.

Such discrepancies would be almost unthinkable in the public bond market.

Over time, he believes valuation practices will need to become more professional and align more closely with the standards of public capital markets.

No systemic risk

Despite these challenges, Karoui does not see a threat to financial-system stability.

Defaults and losses could rise in the event of an economic downturn. However, the conditions for a systemic crisis similar to the global financial crisis are not in place.

«The risk of a systemic shock stemming from direct lending appears very low to me,» he said.

Unlike before the financial crisis, private-credit funds employ only limited leverage. In addition, the increasingly popular evergreen and semi-liquid structures include redemption restrictions designed to prevent forced asset sales.