Affordability is a key issue: Dickson

Key Concepts

• Earnings Growth & Participation: The idea that broader earnings growth across more companies, particularly small and mid-cap stocks, will be a key market driver in 2026, surpassing the influence of interest rate fluctuations.
• Small & Mid-Cap Stocks: Companies with smaller market capitalization (S&P 600, Russell 2000) exhibiting stronger growth potential.
• Cyclical Stocks: Stocks whose performance is closely tied to the economic cycle, benefiting from economic expansion (Industrials, Materials, Banks).
• Consumer Resiliency: The continued strength of consumer spending despite economic uncertainties.
• Affordability Theme: Government policies focused on improving affordability, particularly regarding credit and housing.
• Beta: A measure of a stock's volatility in relation to the overall market; higher beta stocks are more sensitive to economic changes.
• MBS: Mortgage-Backed Securities – securities representing claims to the cash flows from a pool of mortgage loans.
• Capex: Capital Expenditure - funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment.

Market Outlook for 2026: Focus on Earnings and Broader Participation

The discussion centers on the anticipated market dynamics for 2026, with Mike Dixon of Horizon Investments arguing that stronger, broader earnings growth and increased market participation will be more significant drivers than interest rate movements. While acknowledging recent market volatility, Dixon highlights the strong performance of small and mid-cap stocks year-to-date, specifically the S&P 600 and Russell 2000, which have seen gains of 5-6% compared to the stagnation of large-cap stocks.

Earnings Growth and its Drivers

A key point is the shift in earnings growth concentration. Last year, earnings were heavily concentrated among the largest companies. However, Dixon notes a growing expectation of double-digit forward-looking earnings growth for smaller mid-cap and broader cyclical companies. This positive trend is fueled by two primary factors:

1. Reduced Interest Rates: Lower interest rates over the past 12-18 months have alleviated pressure on smaller mid-cap companies, which typically lack the robust balance sheets and cash flows of mega-cap firms. This allows them to absorb costs more effectively.
2. Strong Consumer Spending: Consumer spending is significantly exceeding estimates and driving GDP growth, prompting upgrades to economic forecasts by the Federal Reserve. This strong consumer base, coupled with a stable labor market (neither rapidly growing nor shrinking), provides a solid foundation for economic expansion. Recent retail sales reports, even with reporting lags due to economic shutdowns, show above-trend performance, and Q3 GDP saw a substantial 0.8% increase, largely attributed to consumer spending.

Consumer Strength and Financial Backstops

Despite concerns about potential consumer fatigue, Dixon observes continued consumer resilience. He points to substantial money market fund assets and significant home equity as potential sources of continued spending power, especially with the possibility of falling interest rates. Positive real earnings further support this outlook. He states, “You still have a significant amount of money on the sidelines when it comes to money market fund assets…with the potential for for falling rates to boost that side of the market.”

Policy Impacts and Affordability

The conversation addresses recent policy announcements, including those related to Venezuela, the Powell effect, and credit card caps. Dixon frames these as part of a broader “affordability theme” driving the administration’s policies. He cautions, however, that the implementation details and ultimate effects of these policies remain unclear, suggesting their short-term market impacts may not be lasting. He notes, “It’s not entirely clear how a lot of these things are going to be implemented and so the short-term market impacts…may not be permanent.”

Sector Focus: Value and Cyclicals

Looking ahead, Dixon advocates for a shift towards value and cyclical stocks, particularly within the small and mid-cap space. He believes that the current economic environment – characterized by falling rates, strong GDP growth, and fiscal incentives like the “one big beautiful bill act” – will benefit sectors with higher beta and cyclical exposure. Specifically, he highlights Industrials, Materials (described as “AI adjacent” due to capital expenditure), and smaller cap banks as poised for strong performance in 2026. He explains, “Industrials and materials…which can be thought of as kind of like an AI adjacent trade getting a lot of that capex put to good use.”

Logical Connections and Synthesis

The discussion flows logically from a broad market outlook to the specific drivers of that outlook – earnings growth and consumer strength. The impact of macroeconomic factors (interest rates, GDP) and government policies is then analyzed, leading to a focused investment strategy centered on small and mid-cap value and cyclical stocks. The core argument is that the market is transitioning from a period dominated by mega-cap tech stocks to one characterized by broader participation and earnings growth across a wider range of companies.

The main takeaway is that investors should prepare for a market environment in 2026 where earnings growth and broader economic participation, particularly among smaller companies, will be the primary drivers of returns, potentially overshadowing the influence of interest rate fluctuations. A focus on value and cyclical sectors within the small and mid-cap space is recommended.