The Big Picture

Briefing.com Summary:

*Valuations remain rich but sustainable in 2026 if projected 15% earnings growth materializes.

*Mega-cap tech stocks face a "prove-it" phase, with gains more measured on good news and the downside sharper if growth disappoints.

*2026 has the potential to be a rebalancing year if the economy and interest rates cooperate.

As 2025 comes to an end, we are struck by the mantra that "the more things change, the more they stay the same."

It was this time last year that we said, "2025 looks like a year the stock market is ready to embrace with high hopes and higher prices." Those hopes were wrapped up in "reduced regulations (check), the extension of the 2017 tax cuts (check), a further reduction in the Fed's policy rate (check), double-digit earnings growth (check), and, if the cohort of pundits has it right, a roughly 10% gain for the S&P 500 (check plus)."

The S&P 500 is actually up 16.1% for the year as we write, excluding dividends, so there is no mistaking the fact that 2025 has lived up to the high hopes and then some after dealing with some temporary despair earlier in the year following the president's "Liberation Day" tariff announcements that upset the global trade order and earnings expectations.

Those onerous tariff rates ultimately got dialed back, and as they did, equity returns ramped up. From their lows in April, the Nasdaq, Russell 2000, S&P 500, S&P 400, and Dow Jones Industrial Average are up 57%, 46%, 41%, 33%, and 32%, respectively.

With that historic run, the market arrives at 2026 sporting a full and arguably rich valuation, just as it did arriving at 2025.

Notwithstanding all the changes that took place in 2025, the S&P 500 trades at 22.0x forward twelve-month earnings, which is the same as where it traded at this time last year.

If nothing else, that goes to show that the market can sustain a premium valuation if earnings growth materializes as expected.

So Far, So Good

There are high hopes for earnings heading into 2026. According to FactSet, S&P 500 earnings are expected to increase 15% in 2026. That positive outlook is rooted in a variety of factors:

• A pickup in productivity that is aided by the implementation of AI across the corporate landscape.
• A continuation of the strong earnings performance by mega-cap companies.
• Robust capital markets activity that features a hot IPO market and increased M&A action.
• The economy remains on a growth trajectory, aided by the Fed cutting rates.
• A reduction in tariff headwinds.
• The arrival of tax refunds that support the resilience of consumer spending.

The chart below captures the optimism surrounding the earnings outlook, evidenced by the rising trend in the forward twelve-month earnings estimate.

When that trend changes, so, too, will the behavior of the market, which has come back to that trend time and again as a touchstone for validating the premium valuation, the Fed's policy shift, the administration's policies, and the AI trade.

The bull market will stumble when the earnings growth outlook gets tripped up. So far, though, so good.

Rebalancing Opportunity

We can't say the stock market is entering 2026 with a full head of steam. It has been slowed of late by AI bubble concerns and worries about tough comparisons and concentration risk that have taken some steam out of the mega-cap tech stocks. Nonetheless, the market has kept its head about it, having benefited from a rotation out of those names and into the rest of the market, as opposed to out of the stock market altogether.

This rebalancing effort is expected to continue—and should continue—in 2026 provided the economy remains on a growth track and interest rates remain tame.

We think the mega-cap stocks can still do okay, but they are transitioning from a stage of getting every benefit of the growth doubt to the prove-it phase, and the bar of growth expectations is exceedingly high. In other words, the risk-reward trade-off, in the near to intermediate term, isn't as attractive as it used to be. Gains will follow good news in a more measured manner, whereas material declines will follow growth disappointments.

That's not a forecast. It's just an observation that we think is starting to register more for investors also paying heed to some shakiness in the labor market, circular financing arrangements in the AI space, stubborn inflation, and a budget deficit that threatens to push up interest rates that hurt longer-duration assets.

Briefing.com Analyst Insight

We think 2026 has the makings of being a rebalancing year. The information technology sector, which accounts for 34% of the S&P 500's market capitalization, stands out as a focal point for rebalancing efforts. The health care, industrials, consumer staples, energy, utilities, basic materials, and real estate sectors combined account for just 31.2% of the S&P 500's market capitalization.

Small-cap and mid-cap stocks, meanwhile, also offer a rotational outlet for flows out of the mega-cap space.

If this rebalancing takes place, what one sees at the S&P 500 index level is apt to belie better gains seen elsewhere. That's simply because the market's top stocks have such a huge weighting in the market cap-weighted index.

It will be a more challenging year for stocks in general, though, if there is a downshift in the earnings growth outlook that is precipitated by rising interest rates, a geopolitical shock, a consumer spending retrenchment, and/or a slowdown in the AI buildout.

That isn't the consensus view. The consensus view, judging by the cohort of pundits issuing price targets, is for the S&P 500 to increase in the neighborhood of 10-15%, which effectively follows the earnings estimate trend and is consistent with the consensus view for positive returns most years.

So, more of the same for all intents and purposes, even with 2026 being a midterm election year, the Federal Reserve destined to see new leadership, and hopes running high for interest rates to come down and for the economic growth to impress with increased productivity, fewer regulations, and supportive fiscal policy.

It all sounds good in theory, but keep your eye on earnings. They will ultimately determine if it is more of the same good returns for the stock market at the end of 2026 or if things have changed.

--Patrick J. O'Hare, Briefing.com