For those who survived part one of the 2026 Market Outlook, you already know the answer to the trivia question. For those who didn’t make it, go back and read to find out.
The question: which Friends character is famously known for “Pivot!”?
Seriously though, let’s continue with the Cornerstone 2026 Market Outlook and briefly outline the pros and cons of 2026:
- Pros
- After three years of annual gains over 20%, the bull market is still alive, and we expect strong earnings to lower “stretched” price-earnings ratios.
- Supportive fiscal policy and the new Federal Reserve further a dovish stance.
- Broadening earnings acceleration that supports economic growth.
- Cons
- Three straight years of annual market gains hitting 20% or more.
- AI industry valuations.
- Midterm election uncertainty.
Now, let’s dive deeper into those headwinds.
- The Bull Market Ageist Narrative
Many are concerned over the stock market strength of the past three years as the U.S. bull market turns three. But if history is any guide, this bull market is only middle-aged.
While last week we focused mostly on bull markets that make it past year three, today we want to zoom out and analyze bull markets going back to 1932. While the current bull market is now up over 90%, that’s still barely half of the average rise of over 170% for the 14 prior bull markets since 1932:
History shows this isn't an old bull market, but a middle-aged one.
It's fair to say that economic and earnings growth are key determinants of bull market duration. But there are plenty of underlying economic, fundamental, and historical data points that support an extension of this bull market, though with more volatility than years past.
In Part One of this outlook, we mentioned how euphoria ends bull markets. There's another old saying that’s relevant: “Bull markets don't die of old age, it’s the Fed that kills them.” But looking at the current Fed and the expected new Fed, we think rate hikes are off the table over the next couple of years.
More evidence of this bull market’s strong underlying support is that since October 2024 (i.e., the third year of the current bull market), the S&P 500’s climbed well over 15% since, which makes it a historical standout:
This is especially impressive considering how some third years have been losing ones.
Additionally, we can reasonably expect the Fed to keep cutting interest rates. That’s a significant contributor to broader stock market leadership.
- Backloaded Gains
Valuations have direct relations to interest rates. And some people are concerned about valuations.
But the acceleration of earnings growth combined with lower interest rates will naturally alleviate the normal P/E expansion experienced throughout year three of this bull market. So, 2026 being another good year after three prior good years is possible:
This combination of increased earnings and decreased rates will provide the support necessary as we get to the second half of the year:
In the latter part of 2026, volatility should subside as we regain certainty and clarity nearing midterm elections.
- Midterm Election Uncertainty
Maybe the most likely reason to expect an increase in volatility compared to the last three years is politics. Weakness typically appears in midterm election years.
We’re preparing for rotational leaders to see what sectors will lead throughout the majority of 2026. Our aim is focused on strong, value-oriented, high-quality equities that pay dividends.
That said, it would be disingenuous to not discuss the usual uncertainty midterm elections bring to markets. Markets return about 10% annually spanning decades, but not in midterm election years.
In the last midterm year (2022), the S&P 500 fell 19%. The prior midterm year (2018) was also tough, with the S&P 500 losing 6%.
Since 1960, stocks have lost 1.1% on average in midterm election years:
However, in pre-election years (like 2027), markets tend to violently reverse to the positive, with an average return of 17.2%. So, be careful about donning the bear suit too quickly.
But focusing on 2026, we expect more choppiness. Since 1990, midterm election years have produced overall “blah” returns from January to September before certainty begins to reestablish itself. That typically leads to a boost beginning early in the fourth quarter:
To be clear, any expected choppiness wouldn’t be from lagging fundamentals, economic policy, or anything of the sort, at least as it stands now. The expected volatility would arise from the market’s worst enemy: uncertainty.
This is why as investors we always need to be looking forward and open to change due to a rotation in leadership. We think this is partly why value and quality areas of the market have been surging recently as “big money” investors once again get ahead of an impending macro shift.
To illustrate this, notice how there was a broadening in the markets as 2025 closed out:
Small-cap stocks gained over 5%, health care stocks surged around 7%, and even the unloved energy sector gained over 5%. Meanwhile, materials, staples, and financials held up well.
Zooming out since December began, this action is clearer as “big money” has been flooding certain sectors to get ahead of what we expect is a continued broadening and leadership rotation:
That chart shows significant strength in energy, financials, health care, industrials, and materials. That’s interesting considering how health care and materials stocks have struggled.
In today’s market, it’s foolish to avoid the technology sector altogether. But we must recognize how the low hanging, speculative AI/tech play is clearly over (i.e.-like the non profitable quantum computing rage from the middle of 2025) As such, we believe 2026 will begin to concisely flush out the tech winners and losers. Winners being those supported by profitability and fundamentals. During this time, it’s possible sideways action in the group will persist as prior quality-driven benchwarmers gain ground in a rotation.
Taking all of this together is why following the data and the money is the philosophical cornerstone to everything we do. It is the only way for us to get up to speed on the trends to come, not the trends that passed.
So, with 2026 being a midterm year, the fourth year of this bull market, strengthening earnings, and supportive economic policy initiatives, we expect a fourth year of positive double digit returns of 10%-14% for the year:
Our conservative year-end target for the S&P 500 is around 7,700, albeit with new leadership and volatility. Parts of next year may feel like a Cedar Point roller coaster in the summer, but it should end positively.
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