Investment Strategy

Preparing for volatility during stability

The VIX is recognized as a key metric for investor fear. It reflects the implied volatility of the S&P 500 Index, which is a calculated assumption of the amount of volatility an underlying asset could experience based on market expectations. The VIX scale ranges from 0 to 100, where 100 represents the highest implied volatility (and denotes the most fear). As of the end of January, the VIX was at 17.4, moderately lower than both the long term average of 19.4 and the 10-year average of 18.3.

Chart 1. Top five events creating investor fear over the past decade based on the VIXSources: Bloomberg and Wells Fargo Investment Institute. Data from February 3, 2016 – February 3, 2026. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

In that 10-year period, the VIX spiked due to five major events, with week-over-week percentage increases ranging from 41% to 176% (see chart above). For perspective, the normal range is expected to be within 7% higher or lower than five trading days earlier. Historically, such market-moving events have been difficult to predict (and avoid) because they are unexpected and have uncertain outcomes.

The highest VIX level was 85.1 in March of 2020 with the onset of the global coronavirus pandemic. What followed were multiple years of heightened uncertainty and volatile index levels. For comparison, the VIX spiked during the global financial crisis in 2008 at 80.9. In both events, unprecedented fiscal and monetary policy accommodation occurred to prevent further economic disruptions.

During periods of market uncertainty, fear of further losses may cause some investors to make short-term allocation changes that are less than optimal. Media headlines often exacerbate the fear. Unnerved, investors may make trades resulting in a loss of purchasing power when markets recover. Further, investors seeking to sell during extreme market weakness have often found less-than-favorable pricing due to higher liquidity and uncertainty premiums during these periods.

A bird in the hand is worth two in the bush

The best defense against unexpected volatility, in our view, is a systematic approach deploying regular rebalancing to designated strategic asset-allocation targets. Some investors may also want to consider adopting a tactical approach that seeks opportunities at a 6-18-month horizon. During market rallies, portfolio risk assets generally increase, tilting the portfolio to higher weightings of those risk assets. During periods of market choppiness, the portfolio could perform differently than the investment objective's expected risk and return profile. In contrast, we would expect portfolios that are regularly rebalanced to strategic asset-allocation targets to perform more in-line with expected investment-objective outcomes.

In portfolio implementation, the timing of rebalancing can be based on allocation threshold breaches or scheduled calendar events. We believe specific breach ranges should be based on investment strategy considerations while best practice dictates calendar-based rebalancing that occurs at least annually.

As the wise traveler prefers one bird in hand instead of two in the bush, the wise investor regularly rebalances to lock in investment gains “in hand” and to potentially mitigate downside risk during market turmoil.

Improving outlook for Emerging Market Equities

Since tariff Liberation Day on April 2, 2025, international equities have outperformed the S&P 500 Index. Emerging Market (EM) Equities (as measured by the MSCI Emerging Markets Index) have been the strongest performer, outperforming the S&P 500 Index by nearly 13%, while Developed Market (DM) ex-U.S. Equities (as measured by the MSCI EAFE Index) have outperformed by 4% through February 2, 2026.

Driving this rotation into international equities has been a turn lower in the U.S. dollar, strengthening global growth, and uncertainties around U.S. trade policies. Also, concern about frothy valuations for U.S. Large Cap Equities has been at the top of many investors’ minds.

Within EM Equities, which have been the strongest performer, we have also noticed a positive shift in the MSCI Emerging Markets Index’s composition. While the asset class has historically been tied to a heavier weighting in commodity- and manufacturing-focused sectors such as Energy and Materials, the MSCI Emerging Markets Index’s weighting toward Information Technology and local-consumption-oriented sectors has grown over the years (see Chart 2).

We believe this shift in composition puts EM Equities in a better position to benefit from the global interest and capital spending on technology and artificial intelligence (AI), while stronger global economic growth should bode well for the consumer-driven parts of the index.

Together, we believe these factors translate to better sector exposure to AI-themed trends, improving global growth, and a subdued U.S. dollar, which supports our view that EM Equities can continue to perform well in 2026.

We remain neutral on both EM Equities and DM Equities ex-U.S.; however, we have become more constructive and believe pessimistic extremes on earnings and sentiment have passed. Therefore, we recently raised our earnings target for the MSCI Emerging Markets Index to $100 and price target range to 1,500 – 1,700. For the MSCI EAFE Index, we raised the earnings target to $180 and price target range to 3,100 – 3,300.

Chart 2. MSCI Emerging Markets Index is becoming less commodity focusedSources: Bloomberg and Wells Fargo Investment Institute. Data as of December 31, 2010, and December 31, 2025. Cons. Discr. = Consumer Discretionary. Comm. Srvcs. = Communication Services. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Emerging-market debt — A source of yield to consider

Fixed-income investors remain focused on capturing attractive yield opportunities; however, it is not difficult to realize that most U.S. fixed-income sectors have become relatively more expensive. In our view, this gives investors an opportunity to consider diversifying yield sources into areas that may have gone unnoticed in recent years.

EM Fixed Income still offers notably higher yields when compared to higher-quality fixed-income assets. Chart 3 displays credit spreads, or the additional yield offered by a riskier bond over a U.S. Treasury, and shows the higher yield offered in EM. EM debt generally benefits not only from general economic strength, but also from the relative insulation of EM economies from U.S policy uncertainty and a weaker U.S. dollar. The higher yield in EM may also provide a cushion for any short-term price volatility.

Chart 3. Comparison of credit spreadsSources: Bloomberg and Wells Fargo Investment Institute. Data from January 30, 2016, to January 30, 2026. Credit spread is the difference in yield over equivalent-duration Treasuries. U.S. Investment Grade (IG) Fixed Income represented by Bloomberg U.S. Aggregate Bond Index. Emerging Market (EM) Fixed Income is represented by JPMorgan Emerging Markets Bond Index Global (USD). MBS (mortgage-backed securities) represented by the Bloomberg U.S. MBS Index. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Chart 3 also confirms that credit spreads are at 10-year record lows, a similar story to other U.S. fixed-income sectors. While yields and future opportunities in EM Fixed Income may be attractive, it is currently quite expensive. For now, we maintain a neutral view on EM Fixed Income, which implies a full strategic allocation. The asset class offers diversification and high income potential, especially in a year where we believe income will be the greatest source of total fixed-income return, but investors may want to watch for any pullback in prices.

Is gold losing its shine?

Gold prices surged nearly 70% in 2025, far outpacing the S&P 500 Index’s 18% gain. After hitting a record high on January 28, 2026, it has pulled back about 14% (as of February 2, 2026). We do not view this pullback as the end of the rally; we view it as an opportunity.

Gold’s extraordinary rise was fueled by a rare mix of macro and geopolitical factors in 2025. Uncertainty around monetary policy, tariff disputes, geopolitical tensions, a weaker dollar, and recession fears, among other factors, pushed investors toward other perceived safe-haven assets. Central banks, especially in emerging markets, amplified this momentum. Having accelerated purchases since 2022, central banks continued buying gold throughout 2025 to diversify reserves away from the dollar. There is also evidence that gold attracted significant speculative investment, based on the large flows into exchange-traded funds. This demand created a meaningful tailwind and reinforced gold’s upward trajectory.

The recent pullback appears to be a healthy correction after an exceptionally strong run. Investor positioning had reached stretched levels across fund flows, futures markets, and technical indicators. Gold also traded over 30% above its 200-day moving average from January 22 to January 29, a difficult level to maintain and one that has often triggered profit-taking. We expect a period of consolidation following such rapid gains.

We do not believe that the bull market is over. Our view is that gold should continue to benefit from persistent geopolitical uncertainty, macroeconomic volatility, and continued central-bank demand. Reflecting this view, we have raised our 2026 year-end price forecast to $6,100 – $6,300 and see pullbacks, including this one, as opportunities for investors to increase exposure.

Chart 4. Gold has significantly outperformed the S&P 500 Index and the Bloomberg Commodity IndexSources: Bloomberg and Wells Fargo Investment Institute. Data as of February 2, 2026. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Mixed signals reveal undercurrents in distressed credit

Many small- and mid-sized businesses that faced elevated debt-service costs and refinancing deadlines in recent years adopted the mantra, “survive ‘til ’25.” Though 2025 is in the rear-view mirror, numerous companies may still face challenges as short-term interest rates have only modestly declined since the recent peak in mid-2024. Our expectation of an additional two federal funds rate cuts, combined with a potential acceleration in economic growth, should provide renewed hope for improving business fundamentals through the remainder of 2026.

As we monitor markets for signs of stress, conflicting signals have emerged, fueling debate over whether business fundamentals have truly bottomed out or if the recent decline in default activity may reverse. One indicator suggesting easing stress is the default rate, inclusive of distressed exchanges. Distressed exchanges are typically out-of-court restructurings intended to strengthen a company’s financial position by reducing debt, extending maturities, or lowering ongoing debt-service obligations. As shown in Chart 5, the default rate that includes distressed exchanges has declined in each of the past five months. Yet signs of improving conditions are offset by other metrics, such as rising distress ratios. These ratios represent the percentage of performing loans priced below 80% of par, a level typically associated with borrower stress. The rising distress ratios may suggest that the current trend of declining defaults (including distressed exchanges) may be short lived.

While these conflicting undercurrents could reflect a transitional phase, we remain favorable on Distressed Credit sub-strategies, as we believe meaningful opportunities persist for portfolio managers to help over-leveraged businesses establish viable paths forward.

Chart 5. Default rates (including distressed exchanges) show recent decline while distress ratios riseSources: Pitchbook (Leveraged Commentary and Data) and Morningstar (Morningstar LSTA U.S. Leveraged Loan Index). Data as of December 31, 2025. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Please see the Definitions section for more information regarding the default rate and distressed exchanges.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, February 9, 2026. Please see Wells Fargo Investment Institute's Asset Allocation Strategy Report for more detailed, investable ideas in each asset group.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Forecasts and targets are based on certain assumptions and on views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Leveraged loans are generally below investment grade quality (“high-yield” securities or “junk” bonds). Investing in such securities should be viewed as speculative and investors should review their ability to assume the risks associated with investments which utilize such securities. Mortgage-backed securities are subject to prepayment, extension, and call risks. Changes in prepayments may significantly affect yield, average life, and expected maturity. Extension risk is the risk that rising interest rates will slow the rate at which mortgages are prepaid. Call risk is the risk that if called prior to maturity, similar yielding investments may not be available to purchase. These risks may be heightened for longer maturity and duration securities. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

Bloomberg Commodity Index is comprised of 22 exchange-traded futures on physical commodities and represents 20 commodities weighted to account for economic significance and market liquidity.

Bloomberg U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.

Bloomberg U.S. MBS Index measures the performance of investment grade fixed-rate mortgage-backed pass-through securities of GNMA, FNMA, and FHLMC.

Default rate: The legacy payment default rate includes Morningstar LSTA U.S. Leveraged Loan Index constituents where the company files for bankruptcy, the facility gets downgraded to D by S&P (excluding distressed exchanges and sub-par buybacks), or the interest payment is missed without a forbearance. The default rate is calculated as the sum of all defaulted amounts in the past twelve months divided by the total amount of outstanding of performing loans 12 months ago.

Distressed exchanges: Include all liability management transactions considered a distressed exchange or default by S&P Global Ratings, a U.S. credit rating agency that publishes financial research and analysis on stocks, bonds, and commodities. Distress ratios represent the percentage of performing loans priced below 80% of par, a level typically associated with borrower stress.

Chicago Board Options Exchange Volatility Index (VIX) is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500 Index and is calculated by using the midpoint of real-time S&P 500 Index option bid/ask quotes.

JPMorgan Emerging Markets Bond Index Global (EMBI Global) covers 27 emerging market countries. Included in the EMBI Global are U.S.-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.

Morningstar LSTA U.S. Leveraged Loan Index is designed to deliver comprehensive, precise coverage of the US leveraged loan market.

MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the U.S. stock market.

An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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