The Quick Read
U.S. Equities: Modest Caution
Fixed Income: Modest Optimism
International Equities: Positive
2026 will undoubtably have bumps along the way, as every year does. However, with a supportive Fed and a U.S. administration that wants the economy to be strong heading into midterm elections, our base case is another positive year for U.S. equities. Given the recent gains and the increased scrutiny of the cost of AI implementation, gains are likely to be muted. Small cap stocks and international stocks are the areas where we believe the chance of outperformance is the greatest. Rebalancing to bond targets after another year of exceptional equity performance seems prudent, with rates still attractive by recent historical standards. As always, maintaining a diversified portfolio appropriate for risk tolerances remains the best way to achieve long-term success.
The Overview
A new President, implementation of worldwide tariffs, Federal Reserve turmoil, and ongoing war that, behind the scenes, involves the world’s two largest economies…and the S&P 500 was up over 15% and NASDAQ up over 20% as of the end of November. Even if they’d known the seismic events that would occur in 2025, few investors would have accurately predicted the market reaction. This is another example of the extreme difficulty in predicting future market performance, and why this outlook won’t be giving price target predictions but rather discussing the factors that could impact various asset classes and the CPR view of that class as a New Year begins. 2026 promises to be another action-packed year, with the Winter Olympics, U.S. midterm elections, new Fed leadership, and a Supreme Court decision on the validity of The President’s tariffs all on the docket. To follow are how CPR believes these factors, and others will impact various asset classes.
U.S. Equities
PROS:
- Stock prices largely track earnings growth over the longer term, and the large AI stocks that have led the market continue to post robust earnings growth. 2026 S&P 500 earnings are expected to rise around 13%, likely a slight improvement over 2025.
- AI is projected to increase efficiency in the U.S. economy, which could support higher profit margins beyond the Magnificent Seven.
- The Federal Reserve has an easing bias heading into 2026, typically a tailwind for equities. A new Chairman is expected in May—and is expected to be a Trump loyalist with a dovish bias.
- Legislation (The Big Beautiful Bill) passed in 2025 and taking effect in 2026 is projected to add liquidity to the economy, which should help to support equity prices.
CONS:
- Valuations are significantly above long-term averages, especially among the leaders, which could lead to lower returns going forward.
- PEG ratios, which take growth into account, make the valuations look more in line with historical averages.
- Concentration in a few large cap tech stocks could lead to a market pullback should investors start to be worried about massive spending not yielding massive returns.
- Tariff uncertainty will weigh on profit margins or heighten inflation if firms continue to pass the costs to consumers.
- Government infighting and chaos could impact sentiment or result in an economic downturn.
- Inflation could be higher than expected, leading to a more hawkish Fed.
TMW Take on U.S. Equities--Economic fundamentals support another positive year for equities, but we expect lower returns and a broadening of the market. Taking gains from large cap growth stocks and reallocating to value and smaller cap stocks, which both have better valuations, seems prudent.
Fixed Income
PROS:
- Corporate balance sheets remain strong, with solid cash balances, enabling companies to service issued debt.
- Default rates remain low, indicating stress among borrowers remains subdued.
- The Federal Reserve is likely to lower rates further, which could pressure longer-term rates lower and boost bond prices.
- Capital needs for AI expansion remains elevated, which should result in quality bond issuances.
CONS:
- Credit spreads are historically tight, which means investors aren’t pricing in much risk. Those conditions don’t last forever, and a widening of spreads would hurt bond prices.
- The lack of U.S. fiscal responsibility concerns bond investors, likely pushing rates higher for all bonds.
- The U.S. Supreme Court could declare the President’s tariffs illegal and force the U.S. government to refund payments made, which would further hurt the fiscal standing of the U.S.
- Already sticky, inflation could reignite with the stimulus hitting the economy. In a worst-case scenario, this could push the Fed to tighten policy.
TMW take on Fixed Income--With corporate balance sheets in good shape, default rates should remain low but given the uncertainty surrounding the U.S. government and the Fed, we suggest maintaining a neutral allocation and a short to intermediate duration. Attractive rates, by recent standards, should allow bonds to fulfill their traditional roles of providing income and portfolio stability.
International Equities
PROS:
- Investor interest in international stocks grew in 2025 as foreign markets sharply outperformed U.S. markets. Historically, international outperformance has been a multi-year process.
- Around 50% of the returns in 2025 were attributed to a weaker U.S. dollar.A dovish Fed and anti-U.S. tariff sentiment will likely push the dollar to weaken further.
- International stocks trade at a discount to U.S. stocks by most valuation measures.
- Recent elections in many countries have put more business and market friendly leaders in place.
CONS:
- U.S. tariffs could weigh on overseas companies, whose products may be in less demand due to higher prices.
- China has been more hostile to the U.S. and is improving relationships with North Korea and Russia.
- Growing geopolitical and trade tensions between the world’s two largest economies could result in policies that would hurt international business.
- Inflation in the U.S. could be higher than expected, resulting in a more hawkish Fed.
- A flat or slightly stronger U.S. dollar would remove the currency tailwind from international stocks
TMW take on International Equities--Despite the strong performance in 2025, many clients remain under allocated. We suggest bringing allocations up to at least neutral, including in the emerging market space, which we have recommended avoiding over the past couple of years.