Hi all,
It’s been a few months since my last post, but the honest truth is there hasn’t been much to say. Since October 1st, the S&P 500 and the Nasdaq 100 are both up about 1%.
We expected a 5-10% pullback in equity markets that would offer an opportunity into the end of the year, and that’s exactly what happened. The S&P and Nasdaq made new all-time highs on October 29th and then proceeded to fall 5.7% and 8.8% respectively. We put a little more cash to work for those clients making periodic contributions and the market has been hyper-focused on interest rates and AI-related stories while the overall indexes have pretty much gone sideways for two and a half months.
2025 may be remembered as the year where almost everything worked. The S&P 500 is up more than 15%. European stocks are up 30%. Our preferred emerging markets ETF (FRDM) is up 49% this year. Gold is up 65% and silver is up 125%.
In our opinion, this is reflexive front running of the current administration’s “run it hot” economic strategy. The contention is our only way out of future debt and economic issues is to “grow our way out of the problem”. While that may or may not end up occurring, what we do know is that it rarely happens in a straight line. Next year is a mid-term election year, and the last two mid-term election years (2018 and 2022) were extremely unkind to stock market investors. So can we expect the same for 2026? Let’s dig in…
- Investors Remain Extremely Bullish
According to the AAII (American Association of Individual Investors), total stock allocations, as a percentage of their overall portfolios, is about the same level as 2018 and 2022 (those years keep popping up in my research). Generally when stock allocations are high, there are less and less incremental buyers and typically a shakeout is needed to sow the seeds for the next advance. Risk/Reward is generally poorest when investors are “all-in”.
2. Artificial Intelligence Is Coming
We believe this is a secular (long-term) trend, that in the short-term will immensely improve the overall productivity of the economy as well as the profit margins of the largest adopters of AI (think Mag 7 companies). As the labor market continues to soften, the Federal Reserve has remained resolute in lowering interest rates to combat this trend and bolster employment. While it’s possible this is more of a story for 2027, we feel a tipping point is nearing where less and less human capital is needed for our everyday lives. While we don’t think that everyone will be displaced immediately, we do think a transition period where traditional labor is redirected into other sectors may be bumpier than most are considering.
3. “Run it Hot”
Similar to the decoupling of gold to the rest of the commodity complex in 2020, we believe that traditional commodities (oil, corn, sugar, soybeans) will provide nice diversification in 2026. As the Federal Reserve pushes on a string (rate cuts don’t provide as much help to the jobs market as people think), we believe the market quickly turns from economic concerns to an “overheating” of economic conditions. Given oil is trading near 5-year lows and equity market valuations are in top 10% of historical ranges, we feel energy, in particular, offers a compelling investment case and we will begin to build this into client portfolios early in 2026.
These are just a few of the potential pitfalls of 2026, but the reality is that things are actually pretty good right now. The economy is growing around 3.5% per year and inflation is around 2.5%, which means that the “real” growth rate is approximately 1%. As mentioned before, the administration will do everything they can to get GDP as high as possible before the midterm elections. Being too negative in front of a government running multi-trillion dollar deficits, interest rates that are heading lower, and the prospect of AI creating another productivity boom akin to the infancy of the internet, feels like a fool’s errand. Short-term concern, mixed with long-term optimism is the right mix for continuing the long-term compounding performance we’ve achieved.
“No pessimist ever discovered the secrets of the stars, or sailed to uncharted land, or opened a new doorway for the human spirit.” – Helen Keller
Happy Holidays Everyone!
– Adam