2026 Market Outlook

January 1, 2026

Stock Investors Must Rely On Tech For A Fourth Year Of Gains

For three years running, tech stocks have made double-digit market-gains possible. Semiconductors have done the bulk of the heavy lifting (think Nvidia), while its six Magnificent customers (Meta Platforms, Amazon, Alphabet, Apple, Microsoft and Tesla) have been in the enviable positions of seeing their share prices soar because of their unrivaled and unprecedented capex spending spree. In many respects, they are operating in a virtuous cycle whereby the more they spend on Nvidia’s chips and other infrastructure, the more their share prices seem to rise.

For those investors who are monitoring tech’s valuations, there’s been only a modest return on investment at this point. And some are worried. The counter to that concern is history: FedEx and Amazon took years building their respective infrastructures before they made a dime. Of course, the AI investors’ gambit is that history will repeat.

Nevertheless, twice last year (and once in 2024) investors did get cold feet, and the word "bubble" was whispered. For some, that stirred recollections of the 2000 - 2002 dot.com bust that lopped off about 80% of the Nasdaq Composite’s value and took over a decade to fully recover. Still, it’s an unworthy comparison.

At the turn of this century, many Nasdaq-listed companies had essentially infinite price-to-earnings ratios (P/Es) because they had no earnings. Today’s tech giants print money. Granted, their AI billions have weighed on their balance sheets. But the Magnificent 7 gained over 25% last year, while their earnings kept their P/Es somewhat in check. (For its part, Alphabet fared great in 2025 having risen 65%, versus 17.9% for the S&P 500.)

Even with those returns, or perhaps because of them, there was profit-taking: jittery investors appropriately diversified into other industry sectors dipping their toes into value stocks, small-caps and foreign equities — areas where valuations are less "optimistic" than U.S. tech.

Just how expensive is tech versus the broader market of stocks? There are several ways to value stocks, but we’ll stick with P/Es.

Keeping in mind that prices are always in flux and that earnings (trailing and forward) can be accounting fiction, the Mag 7’s collective trailing P/E is currently about 28. That’s considerably higher than the S&P 500’s P/E of 22. But that 22, of course, includes Big Tech.

So what if one strips out the Mag 7 from the S&P and only considers the index’s remaining 493 stocks?

Though estimates vary widely, their forward P/E (not their trailing 12-month cited above), was thought to be 20 at mid-year versus around 30 for the full index. That’s a significant difference, though one that has likely narrowed in recent months.

One reason for that narrowing is the market’s appetite for cheaper stocks that also have good growth prospects. After all, with the U.S. economy expanding at an upwardly revised annualized rate of 4.3% in the third quarter, other industries stand to grow their earnings, too.

Economically sensitive cyclicals have been increasing sales and earnings, and small-caps have stood to benefit from lower interest rates. (It’s still unclear, however, if tariffs will harm their bottom line.)

And with the White House moving to develop more federal lands (including offshore parcels for oil and gas extraction), relaxing EPA water and emission standards, reinvigorating the coal sector, and protecting a variety of manufacturers with tariffs, new investment opportunities have arisen.

Even in the small corner of the health care sector, Select Biotechnology soared 36.4% last year — less owing to government policy than to the promise that AI should accelerate drug discovery.

AI even woke up the sleepy utilities sector; the need to power hyperscale data centers may triple demand growth over the next decade, which explains Select Utilities 14.2% return last year.

Note: On p. 5 we show four utility funds we’ve downgraded to Hold. While traditional electric utilities stand to benefit from AI growth, their likely inability to meet higher demand has already forced large-scale generative AI centers to find alternative energy sources. Natural gas turbines and batteries are already sidestepping long lead times while being fast to install and perhaps more reliable than a utility.

Diversify, Diversify
That the Mag 7 has grown to represent almost 40% of the S&P 500 is, itself, a risk. Add to that their premium valuations and you have all the reasons you need to consider diversifying away from tech.

That’s especially true if you’re risk-averse or have a truncated investment time horizon (let’s call it five years) that makes it harder for you to get back to "even" after a correction or worse (Since 2000, the S&P 500 has lost 10%+ on a dozen occasions; in 2022 it plunged almost 20%.)

For the all-stock investor, the simple addition of a value fund is perhaps your easiest first step. Equity-Income and Equity Dividend Income are large-cap value funds with only modest tech exposure of around 10% (versus as much as 50% for Blue Chip Growth).

In place of tech are financial services, health care and industrials whose total portfolio weights are around 45%. Moreover, these funds’ less aggressive sector weights result in less risk — they’re about a third less volatile than Fidelity’s typical large-cap growth fund. To that end, Equity-Income is the largest holding (28%) in the Growth & Income Model.

Another approach to risk reduction would be the addition of a small- or mid-cap stock fund. While Mid-Cap Stock’s volatility of 1.26 tells us that it’s considerably more volatile than the S&P 500 (which is 1.00), when combined with funds that are not highly correlated to it, the "magic" of combining them is that the broader portfolio’s risk is reduced.

If unconvinced, you might consider a stake in Low-Priced Stock. About as volatile as the market (1.04), this mid-cap value fund mostly holds over 500 small- and mid-sized stocks that you likely don’t know from countries you may not have visited. Their common trait: by most metrics, they are comparatively inexpensive.

Needless-to-say, there are many other ways to reduce tech and/or portfolio risk including a shift in asset allocation (increase your bond allocation, hold a dividend-paying REIT fund, or consider buying an international stock fund.)

As to the latter, frankly, we’re not fans. The interconnectedness of the world’s economies and financial markets means that correlations between the U.S. and international stock funds is high. In fact, S&P 500 companies derive 40% of their revenue from abroad. Further, a trade war would likely produce no short-term winners. Nevertheless, holding Global Equity Income might provide some risk reduction over the longer term.

Ahead To 2026
It’s very rare for stocks to deliver five consecutive years of double digit returns. Though it last happened in 1995 - 1999, that didn’t end well (as they often don’t) with the dot.com bust. That said, I believe we can all agree on this: we’re living in unprecedented times — both politically and economically.

Here’s what I find worrisome: consensus expectations for the market are exceptionally high — higher than warranted even for the economic and corporate earnings growth than many on Wall Street have factored into their models.

Interest-rate assumptions may also be optimistic.

While President Trump will most assuredly choose a Fed Chairman he can control, he’ll still be only one vote among a dozen. In the meantime, inflation is range-bound (CPI was 2.7% as of November), meaning that it’s still too high. Raising the target rate to 3% would only be a cosmetic "fix," and cutting rates may make it easier to finance the federal deficit. But both moves simply kick another problem down the road: organic growth at the expense of a bigger deficit. For too long the government has relied on fiscal and monetary stimuli to stabilize and energize the economy. To some degree, the One Big Beautiful Bill Act of 2025 is short-term stimulus financed largely by tariffs.

I’m also worried about another round of tariffs in 2026 and a new trade agreement with two critically important trade partners: Mexico and Canada. Tariffs carry a cost to either the seller, buyer or both. While there’s only scant evidence at this point of their contributing to inflation or reshoring U.S. jobs, I’ve never believed in magic bullets or simple fixes to difficult problems.

Regardless of my concerns, U.S. markets will again have the wind to their back in 2026 for reasons that include a global economy that is expected to grow 2.8% versus our own 2.6%. Credit China (4.8%) and India (6.7%) for more than lifting their own weight.

But with U.S. tech priced to perfection and their impact to our stock market critical, something as modest as a few earnings disappointments could trigger a disproportionately negative response by investors— some of whom may have leveraged their way to great success these years. To that end, my earlier advice stands: be cautiously optimistic.

— John Bonnanzio