Jan 13, 2026 2026 Market Outlook: Cautious Optimism
As we turn the page on 2025 and look ahead to 2026, the investment landscape appears to be shifting in subtle but important ways. The past year delivered surprisingly robust returns across asset classes – the S&P 500 climbed nearly 18% on the back of strong earnings. Inflation, while still above central bank targets, has cooled from its peak, and the Federal Reserve has begun pivoting from ultra-tight policy to a more neutral stance. The global economy proved resilient in 2025 despite numerous challenges, with U.S. growth holding up and international markets staging a comeback in performance. We enter 2026 cautiously optimistic as markets have had three straight years of double-digit growth and valuations are at historically high levels. However, we see several tailwinds, highlighted in our key themes that will likely shape market outcomes this year:
AI Enters a New Phase
The artificial intelligence boom is maturing from hype to real monetization. After years of explosive growth, 2026 marks a pivot toward “Phase Two” where companies must prove ROI on massive AI investments. Leadership in AI will broaden beyond the obvious big-tech winners to the “enablers” – firms providing data infrastructure, cloud services, and robotics that power AI application. AI adoption remains a defining market theme, but investors are becoming more discerning, rewarding those showing concrete revenue gains from AI spend.
Importantly, leadership in AI is broadening beyond the usual mega-cap tech titans. Thus far the “AI winners” have been obvious names like the cloud providers, chip designers, and software giants at the forefront. These firms are still poised to benefit (and many enjoyed stellar profit growth in 2025). But 2026 should also shine a light on the lesser-known “AI enablers” – companies supplying the data infrastructure, advanced semiconductors, cloud services, and even industrial robots that make AI possible.
Geopolitical Fragmentation and Defense Boom
A further step towards protectionism globally, with many wildcards in play (Europe/Ukraine, Latin America, Southeast Asia, Middle East) will lead to increased fiscal spending on defense. In the U.S., defense budgets have been on the rise, with priorities ranging from naval shipbuilding to next-gen drone and missile defense systems. The administration is calling for a substantial increase in defense spending in the next budget. NATO partners in Europe are moving toward defense spending of 3.5% (or more) of GDP in coming years.
Global superpowers are competing to control more natural resources and protect their relative geographies. Nations are racing to secure critical natural resources (like semiconductors, rare earth minerals, and energy supplies) and to onshore key industries. For investors, this means we must watch not just economic indicators, but political ones – trade policies, export controls, and international conflicts can move markets in 2026 just as much as earnings reports. Supply chains may remain in flux, potentially raising costs for multinational businesses.
Fed Policy: Economic Support, in a Different Form
Central banks are cautiously shifting from inflation-fighting to normalization. Rate cuts could be limited in the first half of the year (unless we have surprisingly poor economic data) but we could see some modest Fed balance sheet expansion for the first time in a few years, backstopping US markets and improving liquidity and lending conditions. The effect is that the Fed could quietly inject some extra liquidity into markets in the coming months. This is a subtle but important shift: after a few years of liquidity draining, 2026 might see central banks adding cash into the system again, providing a tailwind – or at least a cushion for both stocks and bonds.
New leadership will come in the second half of the year, which could gradually bring rates down more aggressively than Chairman Powell’s current board. An overheating of the economy is our primary, long-term concern.
Robust Earnings Growth to Continue
After the S&P 500 rose nearly 18% in 2025, driven almost entirely by earnings growth rather than multiple expansion, we expect that a favorable regulatory environment, a resilient US consumer, an acceleration of technologic innovation, and improved liquidity/credit conditions will lead companies to further profitability growth in 2026.
Current valuations near historical highs pose an uphill battle for the S&P 500 to have a improbable fourth straight year of double digit growth. For the market’s P/E ratio to come back down to earth, either the P needs to come down (stock prices drop) or the E needs to move up (earnings grow). We believe the later is more likely. In a year of mid-term elections, policy aimed at the US consumer surrounding credit card rate caps, housing affordability, and stimulus checks all support increased consumer spending. Coupled with a Fed that is becoming less restrictive and the AI productivity gains showing up in companies bottom lines, another strong year of earnings growth is expected.
One caveat: a lot of good news may already be priced into the market after three years of strong gains. Any earnings disappointments or guidance cuts in 2026 could therefore spark outsized stock volatility.
Mergers and Acquisitions to Accelerate
The past few years saw something of an M&A lull. Multiple factors contributed: higher interest rates increased the cost of financing deals, volatile markets made corporate executives more cautious, and regulators pumped the brakes on big takeovers. Under the prior U.S. Federal Trade Commission (FTC) leadership, antitrust scrutiny was intense; many proposed megamergers were challenged or deterred, creating a more difficult environment for consolidation, especially in tech and healthcare. Meanwhile, in the private equity and venture capital world, a downturn in IPOs meant fewer exit opportunities as start-ups and their backers were often stuck waiting for better conditions to sell or go public. Now, conditions are shifting in favor of more deal-making.
The improving liquidity and credit backdrop (with interest rates coming down and banks more willing to lend) will grease the wheels for M&A. We’re already seeing evidence of a rebound. In the U.S., deal volumes and values jumped in late 2025 as rate cuts kicked in. There’s also the potential for shareholder-friendly actions like spinoffs and restructurings as companies seek to unlock value (these often accompany M&A waves). It indicates CEOs are seeing value out there and are willing to bet on future growth via acquisitions. Keep an eye on segments like fintech, media, and energy as well, where we see ripe conditions for consolidation. All told, after a few stale years, deal-making is back, and that’s generally a positive sign of economic vibrancy.
The (Improbable) Return of Diversification
In 2025, a few superstar mega cap names made up over 50% of the S&P 500’s gains. It was a similar story in 2023–2024, when the so-called “Magnificent Seven” tech names towered over the rest of the market. This concentration meant that if you strayed from U.S. large-cap tech and for example, held small caps, international stocks, or even just equal-weighted indexes – you likely underperformed the headline indices. Many investors rightly ask: will this ever change?
EM equities, particularly those in Asia, look attractive as the Chinese economy shows new signs of growth. India and other areas of Southeast Asia are benefiting from youthful demographics and increasing technology adoption and an influx of manufacturing demand.
Within the U.S. market, there are reasons to pay attention to mid-cap and cyclical stocks again. Many of these more economically sensitive companies (in sectors like industrial machinery, regional banking, transportation, and basic materials) traded at discounted valuations after lagging the tech giants. Now, with the economy proving resilient and even industrial activity picking up (thanks in part to infrastructure spending and manufacturing onshoring), these “old economy” names have improving outlooks.
Fixed income is staging a comeback as well. At current yield levels, high-quality bonds offer a real opportunity to earn 4-5% income with much lower volatility than equities. If the economy falters for any reason, bonds could also provide price upside (yields would likely fall further).
That said, it may be improbable to expect the market’s longtime leaders to suddenly fall from grace. The mega-cap technology companies have not only grown larger, they outperformed fundamentally – they delivered exceptional earnings growth and return on capital, which justifies a degree of continued market dominance. Their business models (platforms, cloud computing, AI leadership) are still intact and even strengthening. So, while we encourage broader diversification, we are not forecasting a “downfall” of the tech giants based on current data. In essence, 2026 may broaden market leadership at the margins, but likely won’t invert it. A balanced approach makes sense: participate in the transformative sectors driving innovation but also allocate to the overlooked areas where valuations are compelling, and conditions are improving.
Positioning for 2026
The combination of moderating inflation, a supportive (or at least not restrictive) Fed, resilient economic growth, and ongoing innovation creates a backdrop in which a well-diversified portfolio can thrive. We remain constructive as 2026 begins, albeit cautiously. However, we also recognize that uncertainties persist – be it geopolitical flashpoints, the risk of the economy overheating later on, or simply the high valuations in segments of the market that leave less room for error. As stewards of our clients’ capital, we emphasize quality and balance. That means focusing on companies with strong fundamentals (solid balance sheets, real cash flows, competitive advantages) and on maintaining a mix of assets that can weather different outcomes.
In practical terms, our playbook for 2026 is to stay invested, but be selective and diversified. Use periodic volatility or pullbacks to add to long-term positions in favored themes (such as AI and automation, defense and infrastructure, and high-quality income-generating assets) rather than fleeing to cash.
As always, please don’t hesitate to reach out to your financial advisor with questions or concerns.
Michael Levitsky, CFA®, CAIA®
Chief Investment Officer