January 2026 edition

Having the headlines wouldn’t have helped much

If investors had been lucky enough to receive all the headlines for 2025 on January 1 and invested based on that, it likely would have led them astray. Despite a carousel of concerns, including tariffs, inflation, growth, and geopolitical challenges, and a near-20% S&P 500 decline tied to “Liberation Day,” global markets finished the year with broad-based gains and remarkably subdued volatility. The VIX, or “fear index,” closed the year below 15 versus an April peak of 45. Moreover, fixed income markets provided investors solid returns.

What drove markets higher

Despite shifting narratives, especially in the U.S., earnings were the north star. Valuations for the S&P 500 and across market caps were relatively flat, so earnings growth drove returns. While questions about a tech bubble swirled, only two of the “Magnificent Seven” outperformed.

The S&P 500 technology sector’s forward P/E contracted 8% over the past year and is unchanged over two years. For comparison, the tech sector saw its P/E spike 180% over a two-year period during the late-1990s bubble when prices disconnected sharply from fundamentals. That is not the picture today.

International markets

International developed markets (IDM) shined after severe underperformance in 2024. High expectations for the U.S. and low expectations abroad set the stage for a reversal. Currency strength and valuation expansion drove IDM outperformance, though less so for emerging markets (EM), which were boosted by profits. Zooming out, over five years, U.S. returns remain sharply ahead.

Factor performance

High beta (more aggressive stocks), momentum (strong price trends), and growth outperformed while high quality, value, and low volatility lagged.

Five key questions for 2026

We’ve already encountered the first curveball of 2026: the U.S. takeover of Venezuela’s leadership. At this stage, we don’t expect a significant impact on overall asset prices, though the energy sector will likely feel the effects. Stepping back, we turn our attention to five key questions that will shape the year ahead.

1. How will a softening labor market reconcile with above-average GDP?

Our base case – modest labor improvement on the back of an economic uptick aided by tax relief, solid consumer demand, delayed benefits of lower short-term rates, tariff stability, and ongoing AI-driven capital spending.

2. What are the risks of a sharp rebound in inflation?

With oil in the $50s, housing weakening (roughly 40% of CPI), and wage growth cooling, a sharp and sustained inflation spike appears unlikely. Electricity and commodity prices, tax refunds, and tariff pass-through could create temporary bumps. Given it’s a midterm election year, the White House will likely maintain a focus on trying to keep prices from rising.

3. Will the broadening trade take hold?

The average stock has performed better than many assume. The S&P 500 Equal Weight Index finished near a record high, up 11.4%, signaling healthy market participation even as cap-weighted tech has led.

Historically, leaders of bull markets tend to endure, and AI and technology remain dominant themes with strong earnings momentum.

We see early signs that relative earnings and relative price trends for the equal‑weight index are stabilizing but await more definitive evidence of a turn.

We continue to view modest small- and mid-cap exposure as a way to mitigate concentration risk and capture potential rotation. From a sector standpoint, while we remain positive on technology and communication services, we also see industrials and health care as attractive.

4. Will international outperformance carry over?

We maintain a U.S. bias but have boosted international exposure over the past 15 months. IDM outperformance in 2025 was driven by valuation and currency, while earnings lagged. Emerging markets saw earnings-driven gains.

U.S. prices were stretched heading into 2025, weighing on performance, but relative prices have corrected while earnings trends improve, creating a more favorable starting point for U.S. equities. We are monitoring comparative earnings and the dollar closely before making further shifts.

5. What is the path of interest rates?

Our base case – the Fed cuts rates once or twice, moving toward 3%, with the 10-year U.S. Treasury yield drifting to near 3.75% amid increased volatility.

Whether the Fed cuts only once or twice is not a meaningful difference in our view for the economy or the stock market. Lower rates provide some support at the margin, but we would prefer a strong economy with less need for cuts over a weaker economy requiring aggressive easing. A sharp spike in rates, while not our base case, remains a key risk across capital markets.

Positioning entering 2026

As outlined in our annual outlook, The Seventh Inning Stretch, we expect a modest U.S. economic uptick, while the equity bull market still deserves the benefit of the doubt. High-quality bonds should remain a consistent hitter, offering attractive income, while alternatives for qualified investors expand the playbook. Gold is expected to still provide diversification benefits after an MVP season in 2025.

House view highlights:

• Equities: Favor U.S., large cap, and growth on stronger profit trends and innovation.
• Small & Mid-Cap: Important amid anticipated rotations.
• International: U.S.-focused but see opportunities abroad; EM on upgrade watch.
• Fixed Income: Prioritize high quality; await better conditions to upgrade credit.
• Gold: Remains a valuable diversifier.
• Sectors: Technology, communication services, industrials, and health care

This framework is a starting point. Flexibility will be key—staying aligned with primary trends, identifying opportunities and risks, and adjusting as data evolves.

As always, we will continue to follow the weight of the evidence and keep an open mind