THE INVESTMENT LANDSCAPE FOR 2026
Happy New Year! The beginning of a new year is as good a time as any to take an inventory of important variables affecting investors and to see what the investment landscape looks like. The summary below attempts to do just that.
U.S. STOCK MARKET
The third year of the bull market was a good one. The S&P 500 rose 16.4% in 2025, while its equal-weight counterpart increased by 9.8%. Historically the chance of another up year after three straight annual increases for stocks is about 50%. We think the odds are higher this cycle because the powerful AI bull market theme is alive and well, in our view. A major question for investors surrounds AI. Bulls believe investment in AI is in the early innings (we agree) while bears think AI stocks are in a bubble.
Wall Street firms are overwhelmingly bullish for 2026, with an average gain projected of 11% for the S&P 500 (source: Wall Street Journal). Seeing how the average annual S&P 500 return over the last 100 years is 11% (source: Ibbotson), Wall Street isn’t exactly sticking their necks out. Strategists have lots of interesting things to say but their projections are mostly a marketing exercise. We are bullish, too, going into 2026, but trying to quantify expected gains is a fool’s game.
We continue to be overweighted in tech and AI stocks. Other sectors we like include financials, consumer cyclicals, and industrials. All are expected to benefit from an accelerating economy and solid corporate earnings.
U.S. ECONOMY
Many Wall Street strategists are forecasting a reacceleration in economic growth early in 2026. And that is off an already strong base. The catalyst? Consumer spending should get a bump from tax rebates and the One Big Beautiful Bill Act benefits kick in.
Consumers remain on solid financial footing. Elevated home equity, manageable debt service burdens, and normalized savings rates suggest the consumer is healthy (even if consumer sentiment is weak). Consumer spending has been the dominant driver of GDP growth in recent quarters, suggesting the economy is not solely dependent on AI-related investment to sustain growth. As long as labor markets are stable, consumer spending can be a durable foundation for continued expansion.
The labor market will be a focus early in the year. Initial jobless claims have stabilized in the low 200,000s which indicates that the bout of labor weakness that emerged in 2025 may be behind us. However, if we see an uptick in the rate of job firings, dimming prospects in the labor market could very well spill into softer consumption. We will be closely watching this.
Housing remains frozen but could accelerate to the upside. One reason is low leverage: homeowners owe less relative to their equity balance than virtually any point since the 1950s. Homebuilder order books are surprisingly robust and affordability has been slightly improving as well. Surprisingly strong home builder margins is a reminder that the U.S. housing market remains heavily underbuilt. 2025 was a tough year for housing, but 2026 could be better.
Productivity has been very strong over the past few years, which is disinflationary and leads to stronger jobs growth. Generally speaking, periods of high productivity lead to subsequent strong hiring. Real output per hour (labor productivity) has been rising at the same fast pace as the 1990s and twice as fast as the 2010s. This should continue due to AI and other factors. Productivity growth is the magic that raises standards of living.
Tariffs have been in place since April and have not been the disaster many forecast. They have had little negative impact on economic growth, profit margins, and inflation. Tariff rates look to be peaking around 10%. And the tariffed portion of the inflation basket sits at only 20%.
EARNINGS
Corporate profit forecasts for 2026 are off the charts which concerns us because of the high expectations now built into asset prices. Full year 2025 earnings growth is expected at 12.3% with 2026 at 15.0%. The rosy numbers are primarily due to an accelerating economy and expected strong consumer spending. Profit margins remain near peak levels and have not been impacted much from tariffs. Strong earnings growth seems to be a necessary ingredient for good markets this year.
VALUATION
According to FactSet, the 12-month forward P/E on the S&P 500 is 22.5x while its equal-weighted cousin is about 18.0x. The S&P 500 equal-weight index P/E and price-to-sales ratio are at neutral levels and well below the high points in 2021. Because of the large difference in valuation between the market-cap and equal-weighted indexes, the equal-weighted index may offer downside protection if the mega-caps falter.
FED POLICY
The doves got their rate cut at the December Fed meeting with a likely pause for the foreseeable future. It was the hawkish cut the markets expected. The Fed revised up growth, revised down inflation and maintained unemployment expectations.
Core inflation has run above target (which is 2.0%) for five straight years. So why has the Fed been cutting rates at all? Mainly because the labor market weakened in 2025 and the Fed doesn’t want to drive us into recession with an above-neutral Fed funds rate. In the eyes of the Fed, risks to each side of its mandate are balanced-downside risks to employment are equal to the upside risks to inflation. If that is the case, then the policy rate should be neutral. Many on the committee feel that the neutral rate is lower than the current Fed funds rate. So it is no surprise investors are expecting two rate cuts this year.
Another issue for 2026 is Fed independence. A more dovish Fed Chair is likely on the way in May. Will the new Chair be able to exert independence from the Trump administration? The whole world will be watching. An independent Fed is good for global markets.
WHAT COULD GO RIGHT?
- Earnings come through as forecast and spark higher share prices.
- The Fed continues their easing policy and also stays independent. Interest rates decline.
- Cash continues to come in from the sidelines to push stocks higher (there is still about $11 trillion in money market funds).
WHAT COULD GO WRONG?
- Earnings expectations for 2026 prove to be too high.
- The Fed is perceived to lose their independence.
- Inflation ticks up or the labor market weakens again.
- Companies question the profitability of their AI investments.
FINAL THOUGHTS
Since 1928, the S&P 500 has been in a bull market 78% of the time (source: Bespoke Investment Group). So if you bet against the market, the odds are against you.
We are pleased that the market has broadened out in the last few weeks. We remain bullish on stocks and think the AI theme will continue to dominate investors’ discussions about where the market is headed. Are we in AI’s early innings or is AI in a bubble? The answer to this question may decide the outcome for 2026.