A Strong Year Ends with Caution as Markets Enter 2026

January 5, 2026

Financial Markets

U.S. equity markets closed out a strong calendar year on a softer note, with stocks posting four consecutive sessions of declines before finishing modestly higher on the first trading day of the new year. Friday’s session was marked by relative strength in AI infrastructure names, which outperformed as broader market momentum paused following an extended rally.

A modest easing of trade-related tensions lifted sentiment. The U.S. granted Taiwan Semiconductor Manufacturing Company (TSMC) an annual license to import U.S. chipmaking equipment, a move viewed as constructive for global semiconductor supply chains. In addition, President Trump announced a one-year delay of certain tariff hikes on furniture, cabinetry, and a reduction in anti-dumping tariffs on Italian pasta. While incremental, these actions reinforced investor hopes that tariff policy may prove more flexible in practice than rhetoric alone suggests.

Looking back over the whole year, the technology-heavy NASDAQ led major U.S. benchmarks, returning 21.1%, reflecting continued enthusiasm around artificial intelligence, cloud infrastructure, and platform-scale technology companies. The S&P 500 cap-weighted index followed with a solid 17.9% gain, while performance broadened less meaningfully beneath the surface. The S&P 500 Equal Weight index returned 11.4%, and the S&P Small Cap 600 lagged with a 6.0% advance, underscoring the persistent dominance of large-cap growth.

International equities were a notable bright spot. The MSCI AC World ex-U.S. Index rose 32.4% in U.S. dollar terms, significantly outperforming domestic markets. A weaker US Dollar, improving growth expectations abroad, and a rebound in select international equity markets all contributed to this outperformance.

Geopolitical developments moved sharply into focus following the U.S. capture of Venezuelan President Nicolás Maduro over the weekend. Despite the event’s significance, financial markets have largely taken it in stride, consistent with their long history of discounting geopolitical shocks unless they pose a clear and sustained threat to global growth or financial conditions. Maduro and his wife were detained in a U.S. operation and subsequently indicted in federal court in New York on charges including narco-terrorism conspiracy and cocaine importation. From a market perspective, attention has centered on oil. Although Venezuela holds substantial reserves, production has fallen below one million barrels per day, and the global oil market remains well supplied. While the administration has suggested U.S. energy companies could invest heavily to rebuild Venezuelan oil infrastructure, significant obstacles remain, including decades of mismanagement, corruption, and political instability. Beyond energy markets, the episode has prompted broader geopolitical speculation—from U.S. rhetoric toward Cuba, Mexico, and Colombia to questions about whether the operation could influence global strategic calculations elsewhere. For now, the primary market response has been modest strength in traditional safe havens, such as precious metals. At the same time, risk assets remain sensitive to the evolution of diplomatic and strategic developments. Just as tariff uncertainty was waning, a new geopolitical risk factor took its place. Investors are not yet reflecting the same level of concern as they did with “Liberation Day” in April of last year which eventually drove the S&P 500 down 19%.

Economics

Labor market data released during the holiday-shortened week reinforced the narrative of a cooling but still stable employment backdrop. Initial jobless claims declined to 199,000, below both consensus expectations and the prior week’s upwardly revised level. Continuing claims also fell meaningfully, suggesting limited follow-through from recent layoffs. The four-week moving average edged higher but remains consistent with a labor market characterized by low hiring and low firing.

This assessment aligns with the December FOMC minutes, which indicated that Fed officials generally expect the labor market to stabilize under appropriate monetary policy. However, they emphasized that the outlook remains uncertain and that risks to employment are still skewed to the downside. The minutes revealed little change in the broader policy debate. Most participants supported additional rate cuts over time, though divisions remain regarding timing and pace. Three dissents at the December meeting highlighted this split, with Governor Stephen Miran favoring a larger 50 basis point cut, while Presidents Goolsbee and Schmid preferred to hold rates steady. Fed staff modestly revised their economic growth outlook higher relative to October, and many officials reiterated that further rate cuts would be appropriate if inflation continues to ease. Several participants noted that recent core inflation pressures were partly driven by tariffs lifting goods prices, though most expect these effects to fade over time.

Fed Funds futures pricing was essentially unchanged following the minutes, with futures implying roughly an 80% probability of a rate hold at the January meeting. As inflation concerns gradually subside, investors increasingly expect the Fed’s focus to pivot more squarely toward labor market conditions.

The coming week will be data-heavy, with December ISM manufacturing and services reports (including employment components), the ADP private payrolls report, November JOLTS data, another reading on jobless claims, and the December employment report. Together, these releases will shape expectations for early-2026 policy decisions.

Looking Ahead: Early 2026 Catalysts

Several themes are poised to influence markets as the year unfolds. Artificial intelligence remains central, with significant new large language model releases expected early in the year from OpenAI and Meta amid deepening competition with Alphabet’s Gemini. While competition is intensifying, investors are increasingly focused on whether massive AI-related capital expenditures will translate into sustainable profit growth or whether spending plans may be reassessed as scrutiny increases.

Policy uncertainty remains another key variable. President Trump is expected to announce his nominee to succeed Fed Chair Jerome Powell in early January. This decision could influence perceptions of Fed independence and long-term inflation control. While Kevin Hassett currently leads betting markets, near-term rate expectations remain cautious, with markets assigning only a modest probability to a January cut despite recent cooler inflation data and a higher unemployment rate.

Fiscal and political risks also loom. The next government shutdown deadline is January 30^th, with Congress having made little progress on outstanding appropriations bills before adjournment. An unresolved Affordable Care Act extension adds another layer of uncertainty. As seen in prior shutdowns, delays and distortions in economic data could further complicate the Fed’s decision-making process. As the year progresses, attention will increasingly turn to the 2026 midterm elections, which have historically been associated with elevated policy uncertainty and periods of market volatility.

Legal and trade-related developments add to the backdrop. A potential Supreme Court ruling on the use of IEEPA authorities could inject volatility. However, tariffs are widely expected to remain a feature of the policy landscape regardless of the outcome. Meanwhile, expectations surrounding the “One Big Beautiful Bill” point to a meaningful fiscal tailwind through tax policy, capital expenditure incentives, and depreciation rules, though elevated optimism around these factors could leave markets sensitive to incremental disappointments.

Finally, market leadership remains an open question. As earnings growth across mega-cap technology companies normalizes, we expect a broader distribution of equity performance over time, reducing the outsized contribution of a narrow group of AI-linked stocks to overall U.S. equity returns.

Conclusion

Expectations remain elevated, with earnings estimates pointing to an acceleration in corporate profit growth in 2026. In this environment, company guidance will be critical for determining market leadership and sector performance. Investors will continue to scrutinize AI-related companies in particular and are likely to react strongly to any disappointment amid elevated valuations and expectations.

Clarity from central banks represents another key catalyst, with markets awaiting confirmation of the next Fed Chair nomination and further evidence that inflation pressures are easing without a sharp deterioration in the labor market. As the new year begins, volatility and rotation are likely to persist, especially as policy decisions, geopolitical developments, and capital flows interact with stretched valuations and investor sentiment. A disciplined, diversified approach remains essential as markets navigate the early chapters of 2026.

In the coming days, we will share our Investment Review and Outlook, which provides a comprehensive review of recent market developments and our outlook for the year ahead.

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