We enter 2026 as we left 2025, with stocks edging higher in choppy fashion.  While geopolitics has dented investor enthusiasm in January, the companies that have reported their fourth quarter results have put up strong numbers, particularly the banks.  Economic growth was steady at the last reading, with the labor market weakening a bit and inflation remaining sticky (headline PCE was 2.8%).  Companies appear to be in solid shape.

Here are several themes that will impact markets in 2026:

Corporate Earnings

Stocks move mostly for two reasons: changes in earnings and changes in the multiple of earnings at which stocks trade.  In 2025, earnings powered stocks.  Though the final numbers are not yet in, U.S. corporate profits grew roughly 12%-14% in 2025.  With the S&P 500 Index having risen over 16% in 2025, earnings clearly drove stocks higher.  The forward price-to-earnings multiple for the market has remained elevated at around 22 to 23 times, higher than the ten-year average of around 18 times.  Higher multiples are typical in times of above-average earnings growth, and we expect this strong earnings growth to continue into 2026.  Most Wall Street banks expect overall earnings growth for S&P 500 companies to be around 11%-14% for calendar 2026, and if those estimates prove accurate (or conservative), stocks have a good chance of posting a fourth straight year of gains.

Inflation and the Fed

One of the most intriguing storylines for investors in 2026 is what happens with the Federal Reserve.  With Fed Chief Jerome Powell set to step down in May, who his successor will be is still an open question.  It will, however, be someone very dovish and eager to lower interest rates.  The administration has been explicit on this point, even though political pressure on Fed officials can degrade investors’ confidence in the independence of the Fed.  Whoever the administration nominates for Fed Chair, however, cannot simply reduce interest rates on his or her own. Twelve members of the Federal Open Market Committee (FOMC) vote on whether rates should be changed and by how much. The voting body of the FOMC includes the Fed Chair and six other members of the Board of Governors, plus five presidents of the regional Federal Reserve Banks (who rotate).  Many people seem to think that when the Fed cuts rates, that interest rates move lower across the yield curve, making, for example, mortgages and auto loans cheaper for consumers.  This is not so.  The Fed only controls the Fed Funds rate, which is the overnight rate at which the Fed and other banks lend to each other.  Other rates are longer term and trade in the markets.  Investors set the level of rates on 10-year Treasurys, mortgage rates, and longer-term bonds and loans—not the Fed.  The Fed, by lowering short-term rates, can attempt to influence long term rates, but it is not always successful.  Take today’s circumstance as an example.  So far the Fed has cut the Fed Funds rate by 75 basis points, with 25 basis point cuts in September, October and December.  The day before the Fed started cutting, the U.S. 10-year Treasury yielded 4.04%.  Now, with the Fed having cut by 75 basis points, where is the 10-year Treasury yield? Down 75 basis points as well?  No. It is at 4.25%, up 21 basis points.  While we expect no rate cut in January, we do anticipate a couple of rate cuts later in the year.  The administration hopes that such cuts will also drag down the yields on mortgages and the 10-year Treasury yield (on which many loans are benchmarked). However, if investors come to think that the Fed is cutting rates simply to boost the near-term economy without any regard for containing inflation, they are likely to sell longer-term bonds, putting upward pressure on mortgage rates and the 10-year Treasury.  We think the recent divergence in the Fed Funds rate from the 10-year Treasury yield is due, at least in part, to investors’ growing unease at the prospect of a highly politicized Fed.

Geopolitics Remains a Wild Card

Geopolitical developments can arrive suddenly, unannounced, and do significant damage to investor confidence.  They can also dissipate just as quickly and rejuvenate investors risk appetites. But the main risk out there for the next few years, in our view, is a Chinese attack on Taiwan.  With our own government considering an illegal seizure of Greenland from NATO ally Denmark, the Chinese are probably thinking a little harder about making their own grab for Taiwan.  If the Chinese do invade, the impact on the global economy will be massive, as the vast majority of advanced computer chips (about 90%) are manufactured on the island of Taiwan.  If Taiwan should fall under attack, the global economy will suffer a massive body blow and all bets would be off for global equity markets.

Outlook for 2026

Investors, as they did at the beginning of 2025, face a high bar in the form of a somewhat expensive stock market and plenty of enthusiasm. (Enthusiastic investors are often a contrary indicator, as stocks that have been bid up often have poor long-term return profiles.) We see the labor market continuing to weaken as companies delay hiring due to tariff uncertainties, but also the Fed lowering rates to support the economy. But by and large, companies appear to be poised to continue to increase their profits at a decent clip in the new year.

As always, we welcome your comments and feedback.  Please contact us know if there is anything you would like to discuss about your investments or the markets.

Photo by Alfo Images