The Positives: Valuation, Breadth, and Stimulation

First, let’s look at the bull case. There is a prevailing narrative that the market is expensive, and on the surface, that is true. The S&P 500 is trading at a price-to-earnings (P/E) multiple of 22 to 23 times earnings. However, that premium is largely driven by the Magnificent Seven stocks involved in the massive AI build-out.

If you look at the S&P 500 on an equal-weight basis, it is trading around 17 times earnings. That gap is massive. It tells us that while the rally started with large-cap growth, it could now be rotating into underperforming value-driven names.

A unique strength of our portfolios has been our balance: while we maintained exposure to the Magnificent Seven, we also held an overweight position in value stocks. We believe this dual approach will continue to perform well in this environment. I am also encouraged by recent market breadth, meaning that participation has widened beyond tech. Stocks across the broader universe have behaved well in the first few weeks of January, signaling to me that this is an expanding rally.

This supports our broader theme: The AI Second Inning.

While the AI designers and chipmakers had their initial run, the baton is passing to diversified, non-tech S&P 500 companies that are adopting this technology to boost productivity. As we mentioned at FEMU X, the legacy and large-cap value companies that adopt artificial intelligence early will be able to achieve economies of scale using these new technologies more effectively than anyone else.

The U.S. is currently spending about 50% more on CapEx (Capital Expenditures) and reinvestment than the rest of the world. This widening of market performance away from just the top seven names is a healthy sign for a continuation of this market rally. Capital expenditures beyond AI are expected to expand with easier financial conditions.

The Economic Backdrop

The U.S. economy has been incredibly resilient. For 2026, we see:

1. Growth close to or above 3%.
2. Tariff related cross pressures have so far failed to materialize, which is a welcome outcome for the administration and consumers alike.
3. Stimulus kicking in. We are now entering the back half of the OBBBA Act implementation. The tax cuts passed in January 2025, specifically the $12,000 credit for married couples and $6,000 for individuals, are fully finding their way into the economy, alongside advanced depreciation rules for businesses. Rising tax refunds should boost consumer spending and business investment with an estimated $50 billion to $100 billion extra, representing roughly 0.2% to 0.4% of annual disposable income.
4. New Energy Tailwinds. We are watching Venezuela come back online as a major oil producer. If West Texas Intermediate (WTI) crude breaks down into the low $50s, it acts as a massive, immediate tax cut for the American consumer.

The Fed Conundrum and The Bond Market Vigilantes

We expect the Federal Reserve to look toward cutting interest rates this year. We have already seen the President issue an order to buy $200 billion in Mortgage-Backed Securities to try to lower housing costs, and we know a new Fed Chair will be selected by May.

However, as we discussed at FEMU X, there is a double-edged sword here:

1. The President gets the Fed Chair he wants.
2. That Chair WILL want to cut rates.
3. But the market gets a vote.

If the economy remains in above-trend growth with sticky inflation, Bond Market Vigilantes may force yields higher regardless of what the Fed wants. If the 10-year Treasury yield pushes above 5%, that spells trouble for equity valuations. We are watching this dynamic closely; markets may decide that higher rates are warranted simply because the economy is running at such a hot pace.

The Risks: Debt, Geopolitics, and Private Credit Problems

We cannot ignore the negatives.

Labor demand is weak, but with high margins, limited job cuts, new small business hiring, and steady incomes, conditions should stabilize. It is important to recognize a structural shift: just as the largest segment of the workforce, the Baby Boomers, are exiting at a rapid pace, AI has come on the scene to increase productivity for those remaining.

• National Debt: Our accumulated debt is close to $39 trillion (1.22x nominal GDP) with a $1.7 trillion fiscal deficit. While this has not spooked the bond market yet, we must watch to see if 2026 is the year these chickens come home to roost.
• Geopolitics: A Chinese move into Taiwan remains a critical risk, particularly regarding the semiconductor sector, as Taiwan produces roughly 45% of logic chips and 25% of memory chips globally. Any destabilization there would upset markets instantly.
• Private Credit Warning: We have expressed concern for some time regarding Private Credit and Private Equity. Investors have flocked to these funds for stability, but they lack liquidity. In a scenario where rates move higher or investors rush for the exits (similar to Blue Owl Capital), the lack of transparency and liquidity could force funds to sell their good assets (liquid U.S. stocks) to cover losses in their bad assets. If a yield in the 10-12% range seems too good to be true in this environment, it usually is. We prefer to own assets where we know the price and have liquidity every single day.
• Government Interference: Another potential negative I must highlight is that free markets work. While we do not always agree with the outcomes, the core engine of the U.S. economy has always been the free market. Once big government interferes, it becomes a perilous path. While interference is certainly needed during crisis times, if the markets interpret an overreaching hand of government, certain sectors could suffer from an overhang or fear of regulatory intervention.

The Outlook: What Phil Thinks

So, looking at the positives and the negatives, what is the verdict?

Earnings are the mother’s milk of stock prices. As we enter earnings season, I am watching the Financials closely. With recent deregulation, banks should be working harder, making loans, and creating business. Earnings beget earnings.

The Midterm Cycle: My teammate Michael Passante often points out that during midterm election years, we typically see a drawdown of close to 19%. This year could look very similar to last year: a strong start, a sell-off in the February or March timeframe, and then a recovery.

The Bottom Line

From a practical standpoint, the old adage says: As the first week goes, so goes the month; as the month goes, so goes the year. As of this writing in mid-January, markets are up just under 2%, supported by $7 trillion in money market funds that will eventually search for higher yields.

I believe it is reasonable to expect a decent year, perhaps a 6% return range (less than last year, but still solid). I would not rule out a pullback in the first half, followed by a rally as the bullish sentiments regarding earnings, stimulus, and AI adoption take over.

I also view bonds favorably. Our current portfolio yields sit around 4.5%, but if the Fed cuts rates and inflation cools, we could see another strong year for fixed income.

Emerging markets also look more favorable than European markets, especially as the dollar seems to have found a base against the Euro. Furthermore, the momentum of the Abraham Accords in the Middle East offers a potential investment opportunity; it appears the administration, along with large Middle Eastern governments, is lined up for massive expenditures and, hopefully, peace in that region.

A Final Note on Global Stability

I would like to expand on the geopolitical landscape here, specifically regarding Venezuela. Whether the recent shifts were driven by narcotics or oil markets, the core issue is energy. If U.S. producers can reclaim the position lost in 2007 when the country’s infrastructure was nationalized, bringing Venezuela back online would be massive for the global economy.

Legitimizing Venezuelan oil will obviously benefit the Venezuelan people, but the advantage to U.S. security interests is even greater. It would sever the illicit trade networks between Venezuela, Cuba, Russia, and China. Furthermore, as global energy supply increases and prices drop, Russia’s war machine will be significantly hampered, making their campaign in Ukraine far more difficult than before.

Additionally, if Iran and the Persian people finally cast off a 40-year brutal religious dictatorship, the Middle East stands on the brink of permanent, generational peace. If that energy-sensitive region enters a peaceful era where economic growth outpaces conflict, it would be transformational, providing a peace dividend as significant as the fall of the Berlin Wall. While these movements are still in their infancy and change will take time, an accelerated resolution would provide a far more bullish backdrop than what we are discussing today.

We are positioned to navigate the volatility, avoid the liquidity traps of private credit, and capture the growth in the broadening U.S. economy.

Here is to a prosperous 2026.