The stock market finished 2025 with double-digit gains for the sixth time in seven years. Apart from the 2022 downturn caused by inflation concerns, this impressive run has strengthened the financial positions of many investors.
There’s a common saying that anticipation exceeds reality. While investors always welcome strong returns like these—which clearly benefit portfolios and long-term financial objectives—they often become apprehensive once gains are achieved. This is particularly true when major indices reach record highs and valuations climb toward levels not seen since the dot-com era. The positive news is that market gains have expanded beyond AI-related stocks, international equities have recovered, and fixed income has provided portfolio stability.
Throughout 2025, several key issues that have concerned investors over recent years reached inflection points. Inflation, which continues to impact households, has stabilized near 3%. Despite being elevated by historical standards and causing market volatility in 2025, tariffs have not triggered the economic disruption many anticipated. The Federal Reserve has maintained its rate-cutting cycle, and economic expansion has proceeded at a solid pace.
Taking a broader view, the most valuable insight heading into the new year may be that investors’ greatest fears often fail to materialize. The recession widely anticipated since 2022 never occurred. Historical patterns show that for every actual market disruption—such as the 2020 pandemic or 2008 financial crisis—there are numerous feared “black swans” (rare, unexpected events) that never happen. The real challenge for long-term investors is not forecasting which events will prove significant, but rather maintaining perspective and discipline regardless of market conditions.
Looking toward 2026, the investment environment offers both potential and obstacles. Headlines will likely focus on topics including the midterm election, new Federal Reserve leadership, AI’s evolution, rising loan concerns, U.S. dollar movements, and other issues. The critical factor is not whether investors can accurately predict every development, but whether their portfolios are structured to withstand uncertainty while capturing long-term appreciation. The following seven themes can help frame investor thinking for the year ahead.
Multiple asset classes are contributing to portfolio performance heading into 2026
A significant development for investors approaching 2026 is that numerous asset classes are adding to portfolio gains. This contrasts with much of the previous decade when U.S. equities dominated global markets. Throughout 2025, international stocks have outperformed domestic markets, with developed market equities (MSCI EAFE) and emerging market equities (MSCI EM) each rising approximately 30% in U.S. dollar terms. Two primary factors have driven this performance: enhanced growth projections across various economies and dollar weakness, which amplifies returns for U.S.-based investors.
Fixed income has also provided crucial portfolio stability. The Bloomberg U.S. Aggregate Bond Index advanced roughly 7% as the Federal Reserve maintains its rate-cutting policy and inflation remains stable. Higher-quality bonds have fulfilled their intended function by generating income and counterbalancing equity market volatility during periods of uncertainty.
Looking ahead, this highlights the value of balance and diversification. While headline-driven portfolio adjustments may seem appealing, investors who maintain alignment with their financial plans are more likely to be rewarded.
Equity valuations are nearing dot-com era peaks
Strong multi-year returns have pushed stock market valuations higher. The S&P 500 currently trades at a price-to-earnings ratio of 22.5x, approaching the record high of 24.5x achieved during the dot-com bubble. This means investors are paying more for each dollar of anticipated future earnings compared to recent years.
Valuation concerns typically arise when pricing becomes detached from underlying fundamentals. During the dot-com bubble, for instance, valuations reached unprecedented levels that far exceeded revenues and earnings, as investors favored any company associated with the “new economy.” While today’s valuations are elevated due to AI enthusiasm and sustained economic expansion, corporate fundamentals remain solid. Earnings have grown steadily, with consensus estimates from LSEG suggesting this trend could continue.
Understanding what high valuations do and do not indicate is essential. Valuations do not necessarily forecast near-term market declines, as markets can sustain elevated levels for extended periods. While some worry about an “AI bubble,” not all bubbles burst dramatically. Some deflate gradually as fundamentals catch up—a key distinction between the dot-com crash of the late 1990s and early 2000s and the gradual expansion of cloud computing over the past decade.
Nevertheless, elevated valuations suggest potentially more moderate future returns, as markets have already factored in anticipated growth. This can also heighten market sensitivity to disappointments. Such markets are often described as “priced for perfection,” where even small shortfalls in earnings or economic data can trigger volatility. This underscores the growing importance of selectivity and maintaining balance across various market segments—including asset classes, sectors, sizes, styles, and more.
AI continues to fuel economic expansion and investment returns
AI has captured investor attention more than perhaps any other trend. Capital expenditures on AI infrastructure reached exceptional levels in 2025, with total investment easily surpassing trillions of dollars. This encompasses building new data centers, acquiring equipment like GPUs, and hiring AI researchers.
Some investments involve arrangements that appear circular. For instance, Nvidia invested up to $100 billion in OpenAI, which subsequently purchases millions of Nvidia’s chips. These interconnected relationships have sparked questions about whether the AI ecosystem can sustain itself if enthusiasm diminishes.
These patterns reflect the reality that AI infrastructure requires resources few companies can afford independently. The question is whether the technology will ultimately deliver sufficient value to justify the massive expenditures. Currently, AI investment represents a substantial contributor to overall economic activity.
Survey data indicates that businesses are increasingly integrating AI into their operations. According to the Census Bureau’s Business Trend and Outlook Survey, the percentage of businesses reporting AI use more than doubled from 4% in September 2023 to 10% in September 2025. The share of businesses expecting to use AI within six months increased similarly, rising from 6% to 14% over the same timeframe.1 While these figures have jumped, significant room for growth remains.
For investors, AI presents both opportunity and risk. The Magnificent 7 technology companies continue driving market gains, powered by infrastructure investments and expanding AI tool adoption. However, this concentration creates vulnerability. These companies now comprise approximately one-third of the S&P 500, meaning most investors hold substantial exposure, whether they recognize it or not.
The question is not whether AI will reshape the economy—it clearly will. Rather, it’s whether current valuations appropriately reflect realistic timelines for returns on these enormous investments. History from the railroad expansion of the 1860s to the dot-com era of the 1990s demonstrates that transformative technologies often follow similar trajectories: initial skepticism, rapid adoption, market enthusiasm, and eventual integration into the broader economy.
The critical lesson is that markets frequently overestimate how quickly profits can be realized. Most investors likely have AI stock exposure either directly or through major indices, so recognizing this concentration and maintaining an appropriate asset allocation aligned with long-term objectives will be essential in the coming year.
Economic expansion is moderating but remains healthy
Economic growth has decelerated but remains more robust than many anticipated. U.S. GDP experienced a modest negative dip in the first quarter of 2025, but rebounded swiftly as tariff uncertainty subsided. The 3.8% growth rate in the second quarter not only surpassed expectations but represents one of the strongest quarterly advances in years.
Regarding global GDP, the International Monetary Fund projects growth could ease marginally from 3.2% in 2024 to 3.1% in 2026. Advanced economies are projected to expand around 1.5%, while emerging markets are expected to sustain growth above 4%.2
While aggregate growth remains positive, economic expansion has been uneven across income groups and sectors. This phenomenon is often described as a “two-speed” or “K-shaped” economy, where some experience growth while others face challenges.
In the current economy, this divergence is primarily influenced by technology trends, as those positioned to benefit from AI growth may enjoy better job prospects than those in traditional industries. However, factors beyond AI matter, as consumer debt, auto loan delinquencies, and other financial pressures can determine whether individuals benefit from economic expansion.
Regarding long-term economic growth, the most critical question may be whether productivity will increase due to recent technological advances. Productivity measures how much output, in quality or quantity, a worker can generate in a given timeframe. Historically, improved equipment, training, and education have driven greater productivity, which fuels real economic growth.
As the chart illustrates, productivity growth averaged just 1.2% annually during the 2010s. The promise of AI and new technologies is enhanced worker output. However, this often materializes more slowly than expected and may not benefit everyone equally. For investors, the prospect of improved productivity means profit margins could strengthen, supporting the broader economy and portfolios.
Tariff impacts continue to evolve
Although tariffs drove much of the stock market volatility in 2025, their economic effects have been mixed. One ongoing puzzle is how limited the immediate impact of tariffs has been on inflation and growth. Despite tariff costs rising to ten times their historical average levels, measures like the Consumer Price Index have increased only modestly.
Several factors may explain why tariffs have not produced their anticipated effects. First, many announced tariffs were quickly paused or reduced. Second, numerous companies absorbed initial tariff costs by maintaining stable prices and importing goods ahead of tariff announcements. Finally, robust consumer spending, fiscal stimulus, and strong growth in AI-related sectors helped offset any negative impact on overall expansion. Additionally, the Supreme Court may rule in 2026 on the legality of the economic justification underlying these tariffs.
For long-term investors, recent developments, along with the initial round of trade negotiations in 2018, demonstrate that tariffs remain part of the government’s policy toolkit. Rather than viewing tariffs as a fundamental shift in global order, they represent instruments for the administration to advance broader policy objectives. While tariffs will persist, their influence on daily market activity may diminish.
Midterm election and fiscal policy will dominate headlines in 2026
Beyond trade policy changes, 2025 witnessed a historic 43-day government shutdown and persistent concerns regarding budget deficit size. Simultaneously, the recently enacted One Big Beautiful Bill Act (OBBBA) tax legislation has provided greater clarity for investors and taxpayers.
The new year begins with additional Washington uncertainty as the short-term funding bill expires at the end of January. This could trigger another round of negotiations potentially resulting in another government shutdown. Subsequently, some investors anticipate households and businesses will benefit from larger tax refunds due to OBBBA provisions such as full expensing of research and development.
Further ahead, investor attention will likely turn to the midterm election and its implications for tariffs, regulation, government spending, and other policies. The chart shows that midterm elections have historically produced healthy returns, averaging 8.6% since 1933, even if slightly below non-election and presidential election years.
Nevertheless, the greatest concern for many investors remains the expanding national debt. The reality is that the historically high national debt, hovering around 120% of GDP for total debt (over $36 trillion), is unlikely to be resolved soon. In fact, estimates suggest the OBBBA could increase the national debt by over $4 trillion in the next decade. Currently, the national debt amounts to over $106,000 per American.
For long-term investors, recognizing what we can and cannot control is essential. The national debt has challenged policymakers for decades, yet making investment decisions based solely on these concerns would have resulted in poor portfolio positioning. While U.S. federal debt sustainability may affect economic growth and interest rates, history demonstrates this should not be the primary portfolio driver.
Instead, what investors can control in the near term is understanding key tax legislation changes and their impact on long-term planning. These include the permanent extension of lower tax rates from the Tax Cuts and Jobs Act, elevated estate tax exemption levels, increased SALT deduction caps, and numerous other provisions. Now is an ideal time to review tax strategies to ensure full advantage of these new rules.
The Federal Reserve will continue supporting economic stability
The Fed resumed rate cuts in September after pausing earlier in the year. Entering 2026, the monetary policy trajectory may become less predictable. This is because runaway inflation risk may no longer be the primary concern as labor market weakness has gained importance. This requires policy rate adjustments rather than dramatic shifts like those witnessed in 2022.
An additional complication is that Fed Chair Jerome Powell’s term expires on May 15, 2026, creating an opening for new Fed leadership. The White House is expected to appoint a successor who may support additional rate cuts to advance the administration’s economic agenda of lower interest rates.
The chart demonstrates that the economy has performed well across Fed Chairs appointed by both parties. Importantly, the Fed only controls the “short end” of the yield curve—interest rates closely tied to the federal funds rate. Long-term interest rates depend on numerous other factors, including economic growth, inflation, and productivity. Rather than tracking the Fed’s every action and analyzing every statement, investors should focus on these longer-term trends to understand their impact on interest rates and bonds.
Keeping perspective as we kick of 2026
As we kick off a new year in 2026, investors confront a familiar challenge: balancing concerns with the reality that markets have consistently rewarded patient, disciplined investors over time. The catalog of worries is always present, yet history indicates that for every crisis disrupting markets, many more feared events never materialize. What distinguishes successful long-term investors is not the ability to predict which concerns matter most, but the capacity to remain balanced throughout all market cycle phases and disciplined in your approach.
Markets have generated strong returns, yet again, but elevated valuations and moderating global growth suggest more tempered expectations for 2026. Rather than trying to time the market based on any single concern, investors should focus on maintaining balanced portfolios positioned for multiple outcomes.
References
1. https://www.census.gov/hfp/btos/data_downloads
2. https://www.imf.org/en/publications/weo/issues/2025/10/14/world-economic-outlook-october-2025
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