The 2026 market decision is already accompanied by ‘Buy, but…’
As consensus forms on next year’s investment outlook, it’s hard to find much downside in the stock market. But an economic mix that has not been visible for more than half a century means few estimates have been produced without serious qualifications.
The biggest puzzle in 2025 will not be how markets shrug off US President Donald Trump’s tariff war, but rather how the surge in artificial intelligence investment manages to accelerate without creating many jobs.
As economists at JPMorgan point out, the juxtaposition between an AI-led capital spending boom and a stalled labor market has not been seen in US expansion over the past 60 years.
AI itself, and the small productivity gains it has produced so far, may provide some answers to this puzzle. Immigration trends and a halt in the supply of workers are also seriously dragging down new jobs.
Many are still worried that the economy will slump. Even so, there is a tendency to rely on – albeit slowing – capital spending as a reason for optimism heading into 2026.
Bulls argue that most AI infrastructure spending should be covered by corporate cash earnings, that stock prices should continue to benefit from such development, and that a “wealth effect” from rising equity values and falling interest rates will help offset falling demand from slower real labor income.
JPMorgan estimates that U.S. household net worth has increased by more than $12 trillion, or about 8%, since the start of the year.
Tariffs imposed on prices may not have been fully absorbed. But tax cuts and spending increases from Trump’s mid-year fiscal bill will take effect early next year.
Currently, JPMorgan’s real GDP estimates for the US and global economies through next year and 2027 are in the range of 2% and 2.9% in those two years, respectively.
‘RISK, WITH HEDGES’
The numbers in the headlines may sound positive, but the “baseline” scenario is also heavily balanced in a series of ifs, buts, and maybes.
Maybe that was the case. However, confidence in the economic picture appears weaker than usual.
If tariffs or even big spending are able to sustain inflation at current levels, is it possible that the Federal Reserve will make deeper interest rate cuts next year?
Trump’s appointees to the board and the Fed chairman could force an easing of the policy. But the White House’s pressure to cut interest rates may be dampened if inflation remains this high, while polls show voters are fixated on the cost of living ahead of November’s midterm elections.
The result is that many investment outlooks are trending toward a bullish year – but all are tinged with caution.
Societe Generale multi-asset strategist summed it up for the year ahead under the headline “Risk, with hedges.”
The impetus for their optimism comes from the AI investment cycle and falling interest rates. US technology and communications companies are expected to generate operating cash flow of $1.25 trillion which they say will grow faster than capital spending in the next two years.
Although price/earnings valuations vary on many levels, SocGen sees the risk premium for equities versus fixed income still well above the more frightening low point of the dot-com bubble in 2000.
SO WHY HEDGES?
The French bank is concerned about the circular nature of AI investments and increasing leverage, the risk of a hawkish Fed turn, and potential volatility in US politics ahead of the midterms.
Interestingly, they also cited the risks associated with large hedge fund activity in the Treasury market as a potential source of problems – something the Bank for International Settlements once again highlighted this week.
‘The $21 TRILLION QUESTION’
Meanwhile, asset managers seem reluctant to give up on stocks or the AI theme – but they all wince at how expensive the dominant stocks in the US have become.
Fidelity International Chief Investment Officer for Equities Niamh Brodie-Machura asked the “$21 trillion question” – or the market capitalization of the US tech sector – and concluded that the AI boom may continue but with increasing monetization concerns and valuation risks.
The answer is diversification and rotation from America towards Europe, Japan or China.
“The AI investment boom is a game-changing trend that will continue to drive corporate earnings higher, but the rewards in some areas may not match the excitement of real-world investors and the stock market,” he wrote.
But he also returned to the core issue.
If AI begins to function fully, its promise of higher productivity will reduce hiring and could ultimately increase the number of layoffs – good for stock prices, wealth and spending, but bad for employment and incomes.
Which direction will the economy lean in next year? Place your bet now.
Source: Reuters
