BIG SURPRISE?: A look into the 2026 stock market

Key Concepts

• Resilient Markets: The expectation that both the economy and markets will demonstrate resilience in 2026 despite negative sentiment.
• AI Beneficiaries: A shift in focus from the development of Artificial Intelligence to identifying companies that will profit from its implementation.
• Recovery Trade: Investing in areas poised for recovery, specifically emerging markets and small-cap stocks.
• Gradual Easing Cycle: The Federal Reserve’s anticipated, slow reduction of interest rates.
• Nominal Growth: A combination of real GDP growth and inflation, used as a benchmark for the 10-year Treasury yield.
• Divided Government: The predicted outcome of the 2026 midterm elections – Democrats controlling the House, Republicans the Senate.
• Private Credit Market: A segment of lending outside of traditional banks, currently under scrutiny for potential risks.

Market Outlook for 2026: Resilience, AI Beneficiaries, and the Recovery Trade

The discussion centers around market expectations for 2026, with a core thesis of resilience despite prevailing negative sentiment. Brian Leavitt, Chief Global Market Strategist, anticipates the economy and markets will prove more robust than many predict, potentially marking a fourth consecutive year of positive performance.

The Shift from AI Development to AI Beneficiaries

Leavitt argues that the market’s current focus on who will develop Artificial Intelligence (AI) is misplaced. He believes the significant opportunity in 2026 lies in identifying who will benefit from the widespread adoption of AI. This represents a shift in investment strategy, moving beyond the technology creators to the companies positioned to capitalize on its implementation.

The Recovery Trade: Emerging Markets and Small-Cap Stocks

Leavitt’s primary investment idea for 2026 is a “recovery trade,” focusing on undervalued assets poised for growth. This includes both emerging markets and small-cap stocks.

• Small-Cap Stocks: He explains that the prolonged underperformance of small-cap stocks is attributable to a lack of catalysts – specifically, a pick-up in economic activity and Federal Reserve easing. With leading economic indicators now improving and the Fed committed to lowering interest rates, these catalysts are emerging, creating a favorable environment for small-cap growth.
• Emerging Markets: Emerging markets have been stagnant due to a strong dollar and the Fed’s previous policy of either tightening or rapidly lowering rates to combat crises. The current, anticipated “gradual easing cycle” by the Fed is expected to allow emerging market central banks to lower interest rates as well, creating a more conducive environment for investment. Historically, emerging markets have outperformed during such cycles. The fact that emerging market bonds are often priced in dollars also provides a benefit.

Interest Rates and the Bond Market

Regarding the bond market, Leavitt predicts the 10-year Treasury rate will likely settle in a range of 4.25% to 4.5%. This prediction is based on an assessment of nominal economic growth – a combination of real GDP growth and inflation. He estimates GDP growth around 2% and inflation around 2.5%, leading to the projected range.

He cautions that mortgage rates will be set above the 10-year rate, dashing hopes for rates falling to 3% or 4% for homeowners. He defines nominal growth as the sum of real GDP growth and inflation.

Political Landscape and Market Impact

The discussion addresses the potential outcome of the 2026 midterm elections, predicting a divided government with Democrats taking the House and Republicans retaining the Senate. This outcome is seen as consistent with historical patterns in the US political system.

Leavitt believes a divided government will likely prevent significant legislative achievements from the Trump administration, limiting the scope of new policy initiatives to bipartisan efforts or executive orders. Historically, markets have performed well under divided government scenarios.

Private Credit Market Concerns

Addressing Jamie Dimon’s recent comments about “cockroaches” in the private credit market, Leavitt downplays the risk of a systemic blow-up. Since Dimon’s statement, no significant issues have emerged, and the fundamentals of the private credit market remain relatively strong. He advises selective investment within this sector but doesn’t foresee a widespread crisis. Spreads in private credit continue to look attractive.

Logical Connections

The conversation flows logically from a broad market outlook to specific investment ideas. The discussion of AI transitions into the recovery trade, which then branches into detailed analyses of small-cap stocks and emerging markets. The bond market discussion is linked to the broader economic outlook and impacts homeowners. Finally, the political forecast is presented as a factor influencing the overall market environment.

Conclusion

The central takeaway is a cautiously optimistic outlook for 2026. While acknowledging negative sentiment, Brian Leavitt argues for market resilience, driven by a shift towards AI beneficiaries, a recovery trade in emerging markets and small-cap stocks, and a gradual easing of monetary policy. Investors should focus on identifying companies positioned to profit from AI implementation and capitalize on the potential for growth in undervalued markets. A divided government is anticipated, which historically has not negatively impacted market performance. While concerns exist regarding the private credit market, a systemic blow-up is not currently expected.