Market Commentary – January 2026
Looking back on 2025, we asked ourselves whether the year turned out as we had expected. As is typically the case, it did and it didn’t. In my commentary from January of 2025, I noted:
“Looking ahead, we anticipate a constructive environment for U.S. equities, supported by strong earnings growth and easing monetary policy…. A 10% market correction would not be surprising, given the strong gains of recent years. However, such pullbacks often create opportunities for long-term investors to increase exposure to high-quality assets at more attractive valuations.”
Predicting a positive year in the stock market is hardly prescient. It happens, on average, seven out of ten years. Hall of Fame baseball players “only” bat around .300. The expectation of a correction was also reasonable, as the “tariff tantrum” in April caused more than a typical correction. The S&P 500 briefly touched bear market territory, dropping over 20% intraday from peak to trough. I’m not proud of short-term predictions coming true, but I am proud of the way our team keeps our clients focused on the opportunities such downturns provide, rather than the temporary pain caused by paper losses.
Predictions aside, 2025 was a historically strong year for markets despite the many events that took place along the way. The S&P 500 returned 18 percent, including dividends, and set a record for earnings per share (profits). The market achieved 39 all-time highs during the year, bringing the total to 954 all-time highs since 1980. That is an average of 21 per year, or nearly two per month, over the past 46 years.
The Bloomberg U.S. Aggregate Bond Index gained 7.3 percent, its best performance since 2020, ending what is arguably the worst five-year period of bond performance any living investor has experienced. High-yield bonds, while riskier, have provided diversification and meaningful excess returns relative to higher-quality bonds since the start of 2020.
International stocks outperformed U.S. markets, surprising both us and many others, driven by lower valuations, diversification benefits, and depreciation of the U.S. dollar relative to other currencies. Earnings for developed international stocks, represented by the MSCI EAFE Index, are expected to grow at a rate of 9 percent, up from 1 percent in 2025, providing an additional tailwind for returns in 2026.
Place Your Bets
Last year at this time, we poked some fun at the market strategists who vastly underestimated the earnings power of U.S. corporations and the resulting 2024 year-end value of the S&P 500. The 2025 strategist predictions were much more on point. The predictions for 2026 are shared here for entertainment purposes only.
The S&P 500 ended the year at 6,845. The average forecast for year-end 2026 is 7,555, indicating a gain of approximately 10 percent. Predictions range from 2 percent to 18 percent.
AI Stocks Continue to Shape the Narrative
Is It a Bubble?
Depending on your view, artificial intelligence (AI) companies and related stocks have dramatically reshaped market expectations, sentiment, and growth potential. The trajectory for many stocks has defied financial gravity, rising to price-to-earnings valuations that have become increasingly concerning to some investors. We’ve witnessed multiple pullbacks in AI-related stocks, signaling that investors are sensitive to news that could derail momentum. For example, in January, China’s DeepSeek announced that its large language model could produce similar results to OpenAI’s ChatGPT at a considerably lower cost (this later proved to be an exaggeration). The tariff turmoil in the spring also raised concerns about the cost and return on investment required to build out AI infrastructure.
Many investors, including us, acknowledge that a bubble may be developing, but it does not appear poised to burst just yet. As with any major technological innovation, there will be winners and losers, and determining which companies ultimately succeed will take time.
Meanwhile, the largest companies, including Nvidia, Microsoft, and Google, continue to grow larger and now make up a considerable portion of the S&P 500 Index. The largest stocks in the index today represent a higher percentage than they did in the late 1990s, raising concerns about concentration risk.
For now, however, the high growth and valuations of these firms have been justified by a commensurate contribution to earnings growth. If history is a guide, leadership at the top will change over time. Compared to 25 years ago (2000), only one company remains in the top 10 by market capitalization – Microsoft:
What the Stock Market Is Signaling
High-quality companies with strong balance sheets and a history of steadily increasing earnings and dividends were largely left out of the 2025 rally. Recently, however, these non-AI stocks have shown signs of renewed momentum. We expect a broader group of stocks to contribute to overall market returns as 2026 progresses.
The reason is straightforward. For AI to deliver on its promises, non-AI companies must increase productivity by adopting AI tools and consuming AI-driven products and services. This will increase their value to consumers and appeal to investors. The market has effectively pulled forward several years of earnings for AI companies while largely ignoring the rest of the market. This is not sustainable over the long term.
As a reminder, FedEx delivered packages in the 1990s for many failed and successful internet companies alike. FedEx is still here.
What the Economy Is Signaling
Most asset owners, including stock and real estate investors, tend to feel the economy is doing relatively well. While inflation has increased the price of goods and services over the past four years, it has also coincided with higher home values and investment returns. Others, particularly households at the lower end of the income spectrum, have found it far more difficult to afford groceries, utilities, insurance, and especially the assets they would most like to own, such as homes and stocks.
It has been a tale of two economies in 2025, and we expect this divergence to continue for some time.
The economy grew at an annualized rate of 2.3 percent in the third quarter, and the Atlanta Fed estimates 3 percent annualized growth in the fourth quarter of 2025. Baby boomers possess an estimated 75 trillion dollars of wealth, and they are spending it on goods, travel, dining, and support for their children. Consumer spending accounts for nearly 70 percent of GDP, making it a major contributor to continued economic growth.
Anecdotally, one of the most common discussions among our advisors this past year involved clients asking whether they could afford to help their adult children. Home prices and health insurance costs have risen sharply. Wages have increased as well, just not nearly as dramatically. This is another signal that the economy is affecting households differently.
Jobs are not going away, at least not yet. While fears of AI replacing repetitive and menial work persist, low levels of hiring have fortunately been accompanied by low levels of layoffs. The current “no hire, no fire” environment appears to have reached equilibrium and remains in place as we enter the new year. A meaningful increase in layoffs would likely have a negative impact on both the economy and financial markets.
Year Two of Trump 2.0
Historically, the second year of a presidential term has been the weakest for stock market performance. Midterm elections often create challenges for the incumbent party, and shifts in Congress can impact policy initiatives outlined during the presidential campaign. While this negative seasonality may be partly psychological, it can still contribute to market volatility.
2026 Outlook
The economy has not experienced a significant recession since 2008, nearly 18 years ago. During that period, the U.S. stock market, as measured by the S&P 500, has experienced only four negative years. Only one of those years produced a double-digit loss, in 2022.
This history often prompts concerns about market timing near all-time highs. As mentioned previously, new all-time highs are incredibly common and, mathematically, a requirement for a rising market over many years. The S&P 500 peaked in October 2007, just prior to the global financial crisis. Even with the worst possible timing, investing a lump sum of one million dollars in an S&P 500 index fund on October 1, 2007 would be worth approximately 5.4 million dollars today.
While we benefited for many years from limited exposure to developed international stocks during a period of significant U.S. outperformance, we did not fully participate in the most recent international rebound. We are now adding selective exposure to developed international markets in our models where appropriate. This adds diversification, takes advantage of lower valuations, and allows us to participate in improving international earnings expectations.
We continue to favor technology investments where appropriate and maintain broad exposure to stocks not directly tied to artificial intelligence. This approach allows participation in AI growth while also benefiting from the productivity gains AI enables across the broader economy. After a stunning year of technology news, 2026 may bring still more. OpenAI and SpaceX are considering going public in 2026, and some estimates indicate they could debut as trillion-dollar companies.
Given the risk that interest rates could move too low too quickly, along with the possibility of even a mild resurgence in inflation, we are broadly diversifying bond exposure across maturities and credit quality to maintain a balanced approach.
Wishing you and yours a happy and healthy new year and a prosperous 2026.
Sincerely,
Chris Proctor, CIMA
Chief Investment Officer
