Despite generally low expectations and a surge in economic policy uncertainty, 2025 has delivered strong returns across equity and bond markets. As we look ahead to 2026, we expect these trends to continue broadly. We believe the economy will continue to grow, earnings will support stocks and bonds will remain an attractive allocation given their yields and diversification potential.

While risks to our base case outlook persist, it is possible that 2026 results in a return to normal: economic growth neither too hot nor too cold, moderate inflation, a more neutral monetary policy, policy stability and private-sector innovation leading to productivity gains and earnings growth.

We expect steady, if moderate, economic growth

Economic growth should continue in 2026, and while we expect a recession to be avoided, growth is likely to slow to around 2.0%, modestly lower than 2025 levels. The economy should be supported by continued capital expenditure from large technology firms, a more accommodative monetary policy and generally easier financial conditions as lending becomes less restrictive. Additionally, fiscal policy is likely to remain stimulative, with lower tax rates, accelerated depreciation and sustained deregulation all supporting the case for sustained growth.

Furthermore, businesses faced significant policy uncertainty in 2025. To the extent they feel greater clarity on economic and trade policy, we could see more optimism and more aggressive growth plans. Similarly, consumer confidence could also see a recovery as a direct result of lower tax withholdings (higher tax refunds) and from gas prices currently near a four-year low.

In aggregate, consumer spending held up through 2025, and we expect this trend to continue to support the economy. However, signs of weakness need to be monitored carefully given its importance to gross domestic product (GDP). Consumer confidence has waned, but these figures mask significant bifurcation across consumer tiers. The higher-income tiers, which account for the bulk of total spending, have significantly outspent the middle- and lower-income tiers, driven in large part by buoyant stock markets that have increased confidence and wealth. Meanwhile, wage growth has slowed for the lower-income tiers while prices have risen, damaging confidence and reducing spending. This bifurcation in wealth and confidence is reflected in strong sales from both luxury and discount retailers, while more casual restaurants have been losing sales to cheaper fast-food providers. Meanwhile, credit card delinquencies have risen, and subprime auto delinquencies are at their highest level since the global financial crisis. 

But the key to consumer confidence and consumption among middle- and low-income consumers is employment. Unfortunately, the labor market showed increased signs of slowing in 2025, with reduced hiring and more frequent layoff announcements. While the unemployment rate is still relatively low, it recently rose to 4.4%, its highest level in four years. The rise may be partly due to increased labor-market participation (people actively seeking work). Still, the related jobs data has been mixed: the duration of unemployment continues to climb to levels typically seen in a recession, but weekly jobless claims have remained relatively steady. The manufacturing sector has been particularly weak, with the most recent data pointing to five straight months of declines, but the extent to which this may have been a reaction to tariff-related uncertainty remains unclear.

The U.S. government shutdown clouded employment data in recent months, making the whole picture more difficult to paint. That said, we remain optimistic that the strong capital investment cycle will continue, supporting economic activity broadly, and there will be sufficient fiscal and monetary stimulus coming in 2026 to support the jobs market.

Monetary policy should remain supportive

The U.S. Federal Reserve (Fed) was in a difficult position in 2025, facing growing concerns about the labor market while inflation remained above its target level. Its decision to cut interest rates multiple times in the second half of the year was supported by its view that goods inflation remained elevated largely as a result of higher tariffs, and that effect was likely to be temporary. We don’t expect this view to change going into 2026, and — absent a significant rise in inflation — we expect the Fed will continue to focus on employment, moving closer to a more neutral (neither restrictive nor accommodative) policy rate. 

However, the market currently appears more optimistic about the pace of rate cuts than we are. As markets have tended to overestimate the extent of rate cuts this year, we suspect it may be a bit too optimistic again. Additionally, we think inflation may be a bit stickier than the market assumes, providing a justification for the Fed to be more conservative in its pace of rate cuts. There has been a seasonal pattern in recent years, with inflation uncharacteristically high in January and February, which could again give the Fed reasons to keep rates unchanged. Finally, the Fed appears split between a hawkish side that prefer to hold rates steady, and a dovish group that advocates cutting proactively to prevent further labor market weakness.  As such, we expect the Fed will be driven by the incoming data and proceed slowly going into 2026.

Stocks: Poised for continued strength

The S&P 500® Index generated double-digit returns in 2023 and 2024 and is likely to do the same in 2025. While that may suggest the index is due for some consolidation, returns have largely been driven by strong earnings, justifying higher valuations. In recent quarters, most companies have exceeded earnings expectations despite the introduction of tariffs, which has resulted in a steady pace of upward revisions from financial analysts. Looking ahead, 2026 is broadly expected to yield stronger earnings growth than in 2025. As earnings are a fundamental driver of long-term market returns, investors have cause to be optimistic.

Our primary concern is that strong earnings have been relatively concentrated, with the top 10 stocks in the S&P 500 Index accounting for an outsized share of total earnings growth. But that has already begun to change, with only two of the “magnificent seven” large technology companies likely to end the year outperforming the broader index. We've also started to see small-cap earnings expectations increase, some rather significantly.

Nevertheless, at present, we remain overweight large-cap stocks. We think we'll continue to see compelling returns coming from the largest, technology-related large-cap stocks, expecting that they can still lead with a positive economic and monetary environment. But we think some cyclical sectors, like industrials, financials and health care, as well as select consumer discretionary companies could see their performance improve in the coming year. 

International stocks outperformed U.S. stocks in 2025, but much of their returns were driven by U.S. dollar weakness and occurred in the first half of the year. As we look ahead to 2026, we continue to favor U.S. stocks over international equities as we expect U.S. economic growth to outperform that of other major developed markets. The primary exception is likely to be Asian emerging markets, where countries like South Korea, Taiwan and China are significant producers of technology products, with China, in particular, becoming increasingly competitive in artificial intelligence (AI).

Bonds: Just the yield

Bonds have historically been an important part of a diversified portfolio insofar as they provided both steady income and some diversification during periods of poor equity performance. While these benefits were unreliable for a number of years due to low or rising interest rates, bonds have since largely returned to their traditional role. With yields back to levels (near 4%) not seen since 2008, we believe benchmark 10-year Treasuries are an attractive holding in a diversified portfolio. And 2025 showed investors that bonds are again acting as a valuable diversifier, rising in both the April and November equity market corrections.

In the coming year, we expect 10-year bond yields to remain in the range established since late 2022. This range, between 3.75% and 4.50%, could be exceeded next year, but is unlikely to exceed 4.25% for more than short periods. Fiscal stimulus and possibly persistent inflation are likely to put upward pressure on yields, but we expect that higher yields will draw in investors eager to lock in those yields for the life of the bond, keeping a ceiling on yields. While shorter, 2-year Treasuries are likely to remain tied to the outlook of Fed policy, we are increasingly seeing more value at the long end of the Treasury curve. 30-year Treasury yields have once again approached 5%, making them an attractive long-term holding while offering the potential for some spread compression relative to 2-year and 10-year Treasuries.

In credit markets, we continue to maintain a bias toward higher-quality investments across asset classes. Credit spreads (the yields paid over comparable Treasuries) across most credit markets are near historically tight levels, limiting the potential capital appreciation from further spread tightening. However, we are not expecting significant spread widening given our generally positive outlook for the economy and corporate earnings. One area of concern, however, is that large-cap technology companies are turning to debt to help fund their massive capital expenditures on artificial intelligence, such as data centers. This could pressure credit spreads higher, but overall, we expect credit fundamentals to remain solid.

Whether in Treasuries or corporate bonds, bonds are increasingly likely to deliver their yield without significant losses or gains from rising or falling yields. But we do think investors need to be a bit more selective about where they get that yield and continue to recommend favoring higher-quality assets.

Preparing for surprises: The good, the bad and the ugly

Our base case for 2026 is a supportive environment for equities and bonds, but surprises are almost always inevitable, and even the best-laid plans are subject to revision as more data emerges. While these realities are the reason we recommend diversified portfolios, we are considering these known risks to our base case outlook.

The good: Better-than-expected growth

There are many potentially positive factors supporting our outlook for stable economic growth. But if everything went right, it is possible that we are being too conservative. In particular, if the recent economic malaise and policy uncertainty have sharpened businesses’ focus, or the benefits of AI start to become apparent sooner than we expect, markets could begin to price in a more significant boost to productivity. Such a scenario would raise forecasts of longer-term growth rates, corporate profits and equity returns. Also, increasing productivity could drive stronger growth without sparking higher inflation.

The good: Declining tariff uncertainty

Uncertainty about trade policy has fallen in recent months, but it could fall further if businesses become confident that long-term, stable trade agreements have been reached. That 2026 is an election year could make this scenario more likely to improve business and consumer confidence in the current administration. Nevertheless, markets disdain uncertainty, so greater clarity in trade policy is expected to reduce risk premiums and thus raise prices. 

The bad: Employment weakness accelerates

Conversely, recent jobs market weakness could worsen more rapidly than we expect, diminishing consumption and scaling back business investment. AI could be a factor, insofar as the number of jobs available for entry-level programmers and customer service positions has already dropped significantly.

While the Fed would likely become more aggressive in cutting interest rates, it could come too late, and recession expectations could accelerate. In such a case, equity indices are likely to fall significantly, and stock picking will become more critical.

The ugly: Rising inflation

It is unlikely and would require significantly stronger-than-expected economic growth, but it is possible that inflation reaccelerates, requiring a response from the Fed. While we expect lower inflation over time, more aggressive trade policy or an external shock causing a surge in prices for an essential commodity like oil are plausible causes. So is robust growth in combination with falling labor force participation sparking higher wages. Such scenarios could both weigh on equity markets and push bond yields higher.

The ugly: AI fails to deliver

Equity investors could grow increasingly concerned about large-scale capital spending without a clear path to monetizing AI. Given the growth in corporate bond lending for AI investment, along with increases in leveraged loans and private credit lending, banks and the broader fixed-income credit market could suffer from a drop in confidence. A further risk to AI’s ability to deliver earnings is an acceleration in competitiveness from foreign-owned AI technologies. China’s DeepSeek advancement in AI briefly prompted a significant drop in U.S. technology stocks earlier this year, and similar announcements with similar or more severe effects should not be ruled out for 2026.

Stay invested, and alert

Our base case remains for a positive environment for stock and bond investing in 2026. While we have outlined some potential risks to our outlook, we believe investors should remain fully invested in a diversified, actively managed portfolio. In the short term, surprises will happen, and a diversified portfolio will help investors withstand periods of uncertainty and, critically, ensure participation when markets inevitably rebound.

We generally favor, over the long term, a strategic bias to being overweight equities relative to bonds as we believe investors are rewarded in the long run for the additional returns stocks typically generate despite increased volatility. 2026 is no different, but we encourage you to speak with your financial professional to ensure your current allocations align with your investment goals.

Before making a change in your investment portfolio, you may wish to consult with a financial professional to determine how that may align with your long-term goals and objectives.