The S&P 500 has started 2026 with a relatively normal 1% gain through February 6, but there have been several dramatic shifts beneath the surface. The two best performing sectors of 2025 – Communication Services (home of Alphabet, Meta, and Netflix) and Technology (home of Apple, Microsoft, and Nvidia) – have been the worst performers so far in 2026, while 2025 sector laggards Consumer Staples, Energy, and Materials have started the year strongest. Within Communications and Tech, the key areas of debate have been around the power of artificial intelligence (AI):
- What return on investment will the megacap companies, Alphabet, Amazon, Meta, and Microsoft, earn on their massive capital expenditures primarily for building AI infrastructure? Combined, these four companies are expected to spend over $650 billion in 2026 capex, representing roughly 2.0% of US GDP.1
- How formidable will AI be as a new disruptive competitor to established industries, in particular enterprise software? In just the past few weeks, the forward price/earnings valuations for the US software industry fell by roughly 40% as investors priced in future competition from AI.2
- To what extent will productivity gains from AI accrue to non-Tech companies who use it to improve their efficiency and service?
Aside from the continuing evolution of AI from simple text chatbots to complex multimodal agents, we will also be focusing on the following key macro topics in 2026:
US Federal Reserve
After cutting interest rates 1.75% over the past 18 months, the US Federal Reserve is in wait-and-see mode, indicating limited urgency for action on either their growth or inflation outlooks. Kevin Warsh’s nomination to be the new Fed chair is notable as his past views showed a support of low inflation and a strong US dollar. Warsh has recently suggested that he is open to more interest rate cuts if AI-led productivity stays high, but the market and commodity prices have fallen since the nomination as investors have so far put more weight on his historically hawkish views, in particular his arguments against quantitative easing.3 Current expectations are for the Fed to cut short-term interest rates another 0.5% by the end of 2026, with the next cut in June or July.4
Fiscal Stimulus and Deregulation
Alongside continued monetary stimulus from interest rate cuts, several provisions of the One Big Beautiful Bill Act take effect in 2026 that could provide a further boost to the US economy. There should be higher tax refunds this year for individuals, helping offset the impact of still-high inflation and a jump in healthcare costs.5 For businesses, the big changes include 100% bonus depreciation and immediate expensing of R&D, which should both encourage increased investment. Continued deregulation should also be favorable to most industries in 2026, with the oil & gas and bank industries in particular set to receive easier requirements.
Equity Market Trends
While US equity valuations remain historically elevated, S&P 500 returns for 2025 were primarily driven by over 13% earnings growth. The S&P 500 is expected to post 14% earnings growth in 2026, and when combined with the sources of fiscal and monetary stimulus above, we remain cautiously optimistic on the outlook for US equities in 2026 barring any significant unexpected shock.6 The US equity market got even more concentrated in 2025, with the top 10 companies now making up nearly 40% of the S&P 500 as of 1/30/2026. We continue to position clients more diversified than this, though we acknowledge that without significant rule changes it is hard to bet against these megacap companies continuing to dominate their industries. Another area to watch for US equity markets in 2026 could be a rise in equity supply in the form of mega-IPOs, with SpaceX, OpenAI, and Anthropic all rumored to be pursuing public listings.
International stocks outperformed the US in 2025 and this has continued thus far in 2026. Part of the reason for the outperformance has been a roughly 10% decline in the US Dollar vs. other major currencies since January 2025.7 International equities remain more attractively valued than the S&P 500 on most metrics versus history, though these advantages decline when you adjust industry differences and the quality of the companies in terms of return on invested capital. We continue to recommend clients keep a proportion of their equity investments in internationally domiciled companies to take advantage of their cheaper valuation and the diversification benefits.
Labor Market Trends
Following a historically tight 2022, the US labor market has cooled in recent years and we now appear to be in a “low hire, low fire” stagnant job market. The percentage of CEOs experiencing hiring challenges has decreased from 92% in Q1’2022 to 33% in Q3’2025, and average hourly wage growth is back under 3.0%.8 While these trends are helpful for inflation and should allow the Fed to continue cutting rates, the state of the US job market will be a key area to watch in 2026. Further weakness could portend a slowdown in consumer spending, which is already occurring in lower-income households.
US Midterm Elections
Historically, midterm election years have been more volatile than normal for the S&P 500 with weaker average annual returns at +4.7% vs. +9.5% for all other years.9 The market tends to perform roughly flat prior to the election and then have a very strong November and December. Some plausible explanations for this phenomenon are (1) opposition candidates are incentivized to highlight everything negative about the ruling party, and (2) the uncertainty of the election outcome tends to cause investors to take a wait-and-see approach. Keep in mind that historical equity market returns have not significantly favored one political party over the other, and if the market happens to be weak going into November, the average one-year returns after the midterm election is +15.4% vs. +7.8% in all other years.
Bottom Line
There are many reasons to be optimistic in 2026, most notably the expectations for a strong economy and earnings growth, but it is important to remember that the high valuation and tight credit spread starting point leaves less room for error, especially in the US market. We plan to remain disciplined with our process of focusing on the long term and owning a diversified portfolio of high-quality companies. Overall, we remain cautiously optimistic and will continue to monitor macro and company-specific developments as they unfold.