By Ellen Hazen, CFA®, Chief Market Strategist
Looking Forward to 2026
We believe that the US economy will continue expanding in 2026, driving double-digit corporate profit growth and enabling equity indices to hold their above-average multiples. The equity market may broaden beyond the largest tech names as earnings growth in other sectors accelerates. Fixed income should return at least its stated coupon, while a steeper yield curve will benefit banks and shorter-duration investments.
In 2025, the US economy demonstrated resilience after an initial tariff scare in early April: GDP rapidly rebounded from -0.6% in Q1 to 3.8% in Q2 and then 4.3% in Q3. The Atlanta Fed GDPNow indicator suggests Q4 will be 3.0%. The negative reading in the first quarter was due to companies front-loading imports ahead of the anticipated tariffs. This reversed in the second quarter, with inventory drawdowns driving the above-normal growth. By the third quarter, though, the import situation had largely normalized, and the largest contributor to the strong GDP report was core personal spending; particularly spending on services, reflecting solid underlying GDP growth despite the initial volatility caused by the tariff disruptions.
We believe that the US labor market will remain soft, but will not weaken further, in 2026. The average pace of new jobs created in the second half of 2025 was markedly slower than in the first half, at an average of only 17,000 new jobs each month, compared to 117,000 in the first half of 2025. Likewise, the unemployment rate has increased from its mid-2023 low of 3.4% to 4.6%, which is still low by historical standards, but not nearly as low as it had been in recent months. On the labor front, reductions in immigration have in turn reduced the need for job creation. Accordingly, while the absolute number of created jobs has fallen, the data still reflect a growing economy, according to a recent paper by the Federal Reserve Bank of Dallas.
In 2026, both fiscal and monetary policy are likely to be accommodative, which will further bolster economic growth. From a fiscal standpoint, economists estimate that the administration’s 2025 tax bill will increase GDP by about 0.4%. Elements of the tax bill include no taxes on tips and overtime, which will increase estimated tax refunds by approximately $1,400 per eligible household. In addition, corporations can now write off capital spending costs faster due to accelerated depreciation, potentially increasing the investment component of GDP.
We expect that the Federal Reserve (Fed) will cut rates once or twice in 2026, providing monetary stimulus to the economy as well. The futures market is currently pricing in just over two rate cuts. FOMC members’ dissents reflect the arguments both for and against additional rate cuts. Arguments supporting more rate cuts include the weaker labor market (above) and the likelihood that President Trump will appoint a dovish chair (i.e., one who favors looser monetary policy). The primary rationale for fewer rate cuts is sticky inflation, which remains stubbornly above the Fed’s 2.0% target. The latest Personal Consumption Expenditure (PCE) deflator was 2.8%. Recent Fed commentary suggests that the committee is willing to tolerate higher inflation in order to maintain labor market stability.
In addition to fiscal and monetary policy providing a boost to the economy, artificial intelligence spending looks set to increase again in 2026. The top four hyperscalers (Alphabet, Amazon, Meta, and Microsoft) are currently expected to increase their capital spending by a third, from $351 billion in 2025 to $467 billion in 2026. Bloomberg Intelligence estimates that AI capital spending accounted for 38% of all US capital spending in recent quarters. In short, as long as the hyperscalers have the cash to spend (they do) and are willing to spend it (they are), this dynamic alone is a meaningful contributor to economic growth in 2026.
What Our Economic Outlook Means for Equity Markets
As we have previously written, equity markets reflect the present value of individual companies’ future cash flows. Thus, a critical input to equity returns is projected corporate earnings growth. The continued solid GDP growth we envision should in turn lead to strong corporate profit growth. Currently, Wall Street analysts estimate S&P 500 profit growth of 12% in 2025, 14% in 2026, and 13% in 2027 – all higher than its single digit historical growth rate. Moreover, these estimates continue to increase – a year ago, the S&P 500 2027 earnings estimate was $332 (9%); today, the 2027 earnings estimate is $352 (14%). As long as the economy continues to grow, we expect that corporate earnings estimates are attainable. Further, we may finally see areas beyond large technology perform well in 2026, as earnings growth is forecasted to accelerate in sectors like industrials and materials while decelerating in technology.
US equity markets in 2025 were a tale of two cities: large-capitalization equities, as measured by the S&P 500 Index, appreciated by 17.5% in 2025, on top of 23% in 2023 and 24% in 2024. The S&P 500’s price-to-earnings multiple, while not extreme, is toward the high end of its historical range at 22x. By contrast, small-sized and mid-sized equity indices performed modestly in 2025: the S&P Small Cap 600 Index (SML) rose by only 6.0% during the year, while the S&P Midcap 400 Index (MID) gained 7.5%. Unlike their larger brethren, both small- and mid-cap indices are trading at average price-to-earnings multiples compared to their history, with SML at 15.4x and MID at 16.4x, as indicated in the chart below.
International stocks – both developed markets (EAFE) and emerging markets (MXEF) – shone in 2025. Like small and mid-sized US stock indices, they started 2025 at undemanding valuations: EAFE at 14.2x and MXEF at 11.8x. Unlike the small-cap and mid-cap US indices, though, the developed and emerging international stock markets experienced both multiple expansion and earnings growth in 2025. The MSCI EAFE index returned 32.0% while the MSCI Emerging Markets Index soared 34.3%. Part of the eye-popping strength in both developed and emerging markets’ stocks for US investors was US Dollar (DXY) weakness, which was down 9.4%. We expect the dollar to face continued pressure in coming months as the US budget deficit and outstanding debt load remain high and as foreign central banks persist in diversifying their reserve assets away from the dollar. On top of a persistently weaker dollar, earnings growth in international markets may further drive equity performance: currently EAFE earnings are expected to grow 9% in 2026 while emerging markets earnings are expected to grow 18%.
What Our Economic Outlook Means for Rates and Credit Markets
Like large-capitalization equities, corporate bonds today are expensive relative to history. Credit spreads of 10-year BBB-rated corporate bonds over Treasuries are about 1.75%, below the long-term median of 2.18%, meaning that bond investors are being paid less than usual to take on credit risk. The higher inflation environment leads us to continue to find Treasury-Inflation Protected Securities (TIPS) attractive, as those bonds appreciate with the inflation rate. We have also found opportunities in securitized products like mortgages, which yield more than core Treasury securities. And in line with equity positioning, an anticipated weaker US Dollar makes international sovereign debt more attractive as well. Because we expect the yield curve to steepen – as Fed policy lowers short-term rates while high deficit and debt concerns keep long-term rates higher – we believe that staying shorter duration in fixed income positioning is prudent.
Risks to Our Outlook
Risks to our economic outlook could be triggered by a number of factors, including additional tariffs, increased adverse geopolitical activity, a decline in artificial intelligence spending, or tighter monetary policy. Conversely, too loose monetary policy could cause inflation to spike which might require the Fed to increase interest rates. Most of these catalysts could lead to both lower corporate earnings and equity valuations; higher rates could hurt fixed income valuations as well. A stronger dollar could lead US markets to outperform international markets, impacting our view that international markets are attractive.
Conclusion
The outlook for 2026 is underpinned by a resilient US economy that has successfully navigated disruptions like the 2025 tariffs. This growth will be supported by accommodative fiscal and monetary policies and amplified by continued robust AI capital spending. While the labor market has softened, it remains consistent with a growing economy due to shifting immigration and labor supply trends.
For investors, 2026 presents opportunities: large-cap US equities remain expensive but may hold their multiples, while small- and mid-cap valuations still provide room for expansion. Furthermore, with a steepening yield curve and above-target inflation, a shorter-duration strategy in fixed income and exposure to TIPS would appear prudent. Ultimately, so long as corporate earnings continue to grow at a double-digit rate, 2026 may well see the S&P 500 notch its fourth annual gain in a row, marked by broadening participation beyond the tech sector.