2026 Market Outlook: Key Signals Amidst Economic Noise By: Stock Market Charlie

2026: Navigating Noise, Finding Signal

Concentrate on factors that genuinely influence the markets in the coming year.

Key Takeaways

• The US market is entering 2026 with a strong and stable foundation, driven by robust profit growth that is expected to continue.

• Tax reductions and interest rate cuts may provide further support for both businesses and consumers.

• Although an AI bubble could eventually become a concern, current stock valuations and market fundamentals do not suggest this as an immediate risk.

• Investors should observe the US Treasury market for any signs that more significant risks, such as deficits or inflation, may become prominent.

The past year has demonstrated the importance of remaining invested despite significant uncertainty and noise.

In 2025, there were substantial changes in the political landscape, disruptions to global trade, a significant stock market correction, a revision of the US tax code, and the longest government shutdown in US history.

Nevertheless, by mid-December, nearly all major assets had yielded positive returns for the year. Most broad stock categories, including US large caps, US small caps, international developed markets, and emerging markets, experienced double-digit percentage increases.

What were some of the key drivers behind these impressive stock market results? Earnings, earnings, and earnings. Strong earnings may rarely make headlines, but amidst a turbulent year, corporate earnings growth has been the quiet engine driving the market, enhancing value and helping investors build wealth discreetly.

Looking ahead to 2026 and beyond, there are no indications that turbulence will diminish. The global stage remains tense, and the US role is evolving. Domestic politics are fraught and deeply polarized. The US federal government is accumulating more debt, with no straightforward solutions. Technology is advancing rapidly, with workers, investors, and companies striving to keep pace.

Despite this, 2026 could prove to be another excellent year for investments. The market is well-positioned. Companies are just beginning to reap the benefits of the new corporate tax breaks enacted in 2025, which could further fuel earnings momentum. The Federal Reserve has been reducing rates, with more cuts potentially forthcoming. The economy continues to grow, and a resurgence in corporate investment (i.e., capital expenditures, or “CapEx”) is laying the groundwork for future growth potential.

In a world filled with noise, investors can benefit by focusing on the signal. Continue reading to explore the key drivers that could genuinely influence markets in the coming year, amidst the distractions.

Signal: Broad-based earnings growth

The earnings growth that propelled stocks in 2025 shows no signs of slowing as we move into 2026. Analysts not only anticipate continued strong growth but also observe signs of a healthier earnings outlook, with a broader range of companies contributing to this growth.

Analysts project that companies in the S&P 500^® Index will achieve double-digit earnings growth for the 2025 calendar year. For 2026, they expect another year of double-digit earnings growth for the group, potentially accelerating compared to 2025.

In much of 2025, earnings growth was disproportionately driven by a small number of large tech companies. For example, in the second quarter, Magnificent 7 companies generated 27% earnings growth, while profits at the 493 other companies in the S&P 500 grew by 8.1%.³ However, this gap appears to be narrowing, with stronger growth anticipated in 2026 for non-tech and smaller companies.

Earnings growth expectations are very robust for 2026—not just for the S&P 500. Earnings expectations have significantly increased for both mid- and small-cap stocks.

The Black Investors Coalition notes that earnings have already surpassed a key threshold for this type of broadening: Median-stock earnings growth finally turned positive in 2025, following a three-year contraction.

Until recently, this earnings recovery appeared strong at the top but weak underneath. This shift in median earnings growth marks a turning point in what has been the narrowest earnings recovery in history.

Of course, there are no guarantees that earnings growth will meet expectations for 2026. However, barring any surprises, the overall economic outlook appears strong.

In the broader perspective, the US and global economies remain in expansion. Despite job market weaknesses in the second half of 2025, near-term recession risks appear low, while the chances of continued economic expansion seem favorable.

Signal: Tailwinds from tax and interest rate cuts

A key signal to watch for in 2026 will be the earnings boost from corporate tax cuts enacted by the One Big Beautiful Bill Act, signed into law in July 2025.

While the tax law did not lower the statutory federal corporate tax rate, which was permanently set at 21% in 2019, it is expected to reduce the effective tax rate through changes in the treatment of certain corporate deductions and expenses—potentially by as much as 7%, according to some estimates.

The US tax-cut package is anticipated to be highly beneficial for corporate cash flows and profitability.

Although the law was passed months ago, most of its economic impacts have yet to be realized. In addition to corporate tax breaks, which can directly boost company profits, the law provides a boost to US consumers through various new and expanded deductions, potentially stimulating consumption and the US economy more broadly.

The stimulus begins in the fourth quarter of 2025, but the most significant effects will be felt in 2026.

While further rate cuts from the Fed are not guaranteed, both the Fed’s own projections and market expectations suggest that additional rate cuts could be possible. Lower rates could support interest-rate-sensitive market segments, such as the housing sector and small companies, which have both faced challenges in recent years. Historically, when the Fed has been able to cut rates during an economic expansion, US stocks have experienced gains fueled by both rising earnings and increasing price-earnings ratios (P/Es).

Potential noise: Worry over high stock-market valuations

By many metrics, US stocks are not inexpensive.

The S&P’s forward P/E ratio (price divided by estimated earnings for the next 12 months) was recently 21.95, compared to a 10-year average of 18.7. Stock prices appear even more expensive when measured against normalized earnings (smoothed long-term profits). By this measure, US stocks recently traded at a P/E ratio of 37.

If valuations remain high or increase in 2026, there may be increased speculation that markets are in a bubble or that stocks are due for a decline.

However, high valuations alone do not cause stocks to decline. Historically, high valuations have often indicated confidence in future earnings potential. Currently, there is significant visibility into future earnings. Valuations may remain elevated for an extended period.

This is not to say that valuations are irrelevant. High valuations imply that positive news is already reflected in the market. They can make stocks more vulnerable to a pullback when issues arise or exacerbate the severity of such a pullback. However, they are not an immediate catalyst.

Signal: The global dollar-diversification trade

One of the most notable market stories in 2025 was the decline of the US dollar. As of mid-December, the US dollar had fallen by 8.7% for the year, relative to a basket of global developed-market currencies. This decline was a key driver of the outperformance of non-US stocks over the past year, with developed-market international stocks up by 28% in dollar terms from the start of 2025 through mid-December.

Currency movements are notoriously difficult to predict in the short term. However, the factors driving the dollar’s decline so far appear intact and could lead to further depreciation in 2026 and beyond. There are several reasons why the rest of the world might seek to diversify some of its dollar holdings. The global landscape continues to shift away from US dominance toward a more multipolar balance of power. Many central banks worldwide have begun diversifying their substantial holdings of US Treasurys. Following several decades of inflows to US-dollar assets from foreign investors, the dollar remains expensive relative to many other major currencies. Additionally, many foreign nations are now investing in their domestic economies in ways that could encourage local investors to repatriate their assets.

On the margins, some non-US investors may be more inclined to seek opportunities in their home countries. Some challenges initially perceived as obstacles to these countries, such as reduced trade with the US or defense assistance from the US, may be prompting domestic spending and creating new growth opportunities.

For US investors, continued dollar weakening may be most immediately felt through higher returns on investments denominated in other currencies (such as non-US stocks). Counterintuitively, a weaker dollar can also benefit many large-cap US companies by increasing the value of revenues earned abroad when these revenues are converted into dollars.

This may be a long-term trend that unfolds over several years or even decades.

Potential noise: Headlines on transitions at the Fed

Questions regarding the Fed’s ongoing political independence gained attention in 2025 and are likely to persist through 2026. The Fed’s composition faces multiple potential transition points in the year ahead, including a vacancy on the Board of Governors in January, the end of Jerome Powell’s term as Chair in May, and an upcoming Supreme Court decision concerning Lisa Cook's status as a Governor.

While the future of the Fed is certainly of interest to the market, the question of its independence is unlikely to hinge on one or two appointments. It’s akin to redirecting a large ship. It’s not easy to suddenly change direction.

Rather than focusing on noise surrounding appointments or legal battles, investors should look for signals that the Fed’s priorities are shifting—such as an increased inclination to cut rates even if inflation remains elevated, or a reevaluation of the Fed’s 2% inflation mandate. Another signal could be if the Fed begins to place more emphasis on controlling long-term interest rates, such as 10-year Treasury rates.

A marginal loss of independence for the Fed would not be unprecedented. Central bank independence is a relatively recent concept. Historically, countries have experienced periods when their central banks were less independent, as was the case with the Fed during the World War II era.

The critical question for investors is whether any concerns about independence could trigger a market reaction, which could occur if the Fed were to pursue policies that appear inconsistent with its mandate of controlling inflation.

Signal: Dynamics in the US Treasury market

While the near- to intermediate-term outlook for stocks generally appears positive, it is undeniable that longer-term forces of change are building pressure beneath the surface. Will concerns about Fed independence begin to unsettle the markets? Could changes in the Fed’s focus weaken the economy's defenses against inflation? And how will the US continue to finance and manage its growing debts?

The fault lines for these complex forces converge in the US Treasury market. For 2026 and beyond, investors should monitor Treasury market dynamics for any signs that such risks may be moving to the forefront.

Consider Fed independence. If the Fed were to lower the federal funds rate below a level justified by economic data, it could raise investor fears about long-term inflation and the Fed’s credibility in combating inflation. These concerns could first manifest in the Treasury market, as investors demand higher long-term interest rates to compensate for the risk of higher inflation.

Or consider the challenge of US debt and deficits. Markets have generally been complacent about the US debt situation and could remain unperturbed for years to come. However, if that were to change, the initial signs might appear in the Treasury market, such as with rising Treasury yields or challenges at Treasury auctions. (Learn more about why investors may need a new diversification strategy in light of the risks posed by high government indebtedness.)

Any volatility in the Treasury market can have spillover effects on other markets, as higher interest rates generally depress stock valuations and prices. Timmer notes that a 5% interest rate on 10-year Treasurys has been a key threshold for the market in recent years, with stocks experiencing brief selloffs when the 10-year rate approaches that level. If Treasury market volatility stems from deeper concerns, such as doubts about the US government’s ability to meet its debt obligations, it could trigger even sharper disruptions across other asset classes.

It's always possible that 2026 may be a quiet year for the bond market, with none of these issues coming to the forefront. However, investors concerned about such issues should watch the bond market for clues.

Signal: The AI boom

The impact of AI on most Americans’ daily lives is still relatively limited, so the widespread AI hype may seem exaggerated.

However, behind the scenes, the impact on the US economy and markets has already been so substantial that it is challenging to convey. Investments in AI infrastructure (i.e., CapEx) have accounted for approximately 60% of recent US economic growth. According to some estimates, global investments in AI infrastructure may exceed $2 trillion in 2026.

This spending generally reflects companies building the infrastructure they anticipate needing for future AI usage—such as data centers, chip solutions, cooling systems, energy, and electricity access—rather than utilizing AI in their business processes. To draw a historical parallel: It’s akin to companies still constructing transcontinental railways but not yet transporting goods on them.

A key difference from railways is that no one can yet definitively state how AI will be used to generate revenue. In that sense, the internet boom may be a more apt comparison.

In the late 1990s, it was challenging for investors to envision the types of business models and companies that would emerge. No one then could have predicted that more than a decade later, a tech company would fundamentally disrupt the taxi-cab market, as Uber did.

Although some companies are beginning to monetize AI at the margins, for most, the timeline for returns remains uncertain. Investors are still investing in anticipation of future potential growth.

These future use cases may be difficult to imagine today, but that does not mean they will not materialize. While the timeline for this development is uncertain, it is likely that most investors are underestimating AI's ultimate impact. In the long term, we are just beginning. Everything starts with intelligence.

Potential noise: Talk of an AI bubble

It is entirely possible that AI enthusiasm could eventually lead to excessive valuations and other hallmarks of a bubble. There is a risk that, in the race to avoid being left behind, companies may over-invest in AI infrastructure, leading to earnings challenges if profits are thinner or slower to materialize than expected.

However, compared to the late 1990s internet bubble, the AI landscape still appears very early and benign. Current valuations are not even close to those experienced during past bubble extremes.

Unlike the excesses of the late 1990s, the current AI build-out has been predominantly funded with cash flow rather than debt. Is there a chance we may see excesses in 2026? Perhaps. But I do not see it yet in earnings, the IPO market, the SPAC market, or any other indicators I follow.

Certainly, investors should continue to monitor valuations and other signs of potential speculative market dynamics in 2026. Bubbles typically do not burst when everyone is expecting one. They burst when skeptics who anticipated one and sold too early succumb to their fear of missing out and re-enter at the peak.

A year rich with risk and opportunity

The year ahead is certain to bring more challenging headlines, whether concerning known risks like politics, trade, or inflation, or unforeseen developments. Every year presents numerous moving parts.

However, for investors who remain disciplined and focused on their financial plans, 2026 could offer opportunities to benefit from a dynamic market environment.

No single year is ever calm in the market. Volatility is a given, but it is also what we thrive on.

If you need assistance developing a financial plan that you can adhere to through the unpredictable ups and downs of 2026 and beyond, learn about how we can work together.

Best Regards,

Stock Market Charlie