Where to Invest in 2026 After This Year’s Market Volatility

Key Concepts

• Market Volatility: Fluctuations in market prices over a period, influenced by factors like tariffs, AI developments, and economic data.
• AI Bubble: Concerns about inflated valuations of companies heavily involved in Artificial Intelligence.
• Momentum Investing: A strategy focused on investing in assets that have shown strong recent performance.
• Value Investing: A strategy focused on investing in assets that appear undervalued by the market.
• Diversification: Spreading investments across different asset classes and geographies to reduce risk.
• Trump Trades: Investment strategies initially favored following Donald Trump’s election, which largely did not persist throughout 2025.
• Risk-On/Risk-Off: Market phases characterized by investor appetite for riskier assets (risk-on) or a preference for safer investments (risk-off).

Investment Performance in 2025: A Year of Surprises and Shifting Leadership

The year 2025 presented a volatile investment landscape, deviating significantly from initial forecasts. Despite early-year turbulence stemming from trade tensions and the aftermath of the US elections, the US stock market ultimately delivered strong gains, though with considerable fluctuations. This discussion, featuring Morningstar Index Strategist and Columnist Dan Leovitz, analyzes the key drivers of performance, identifies leaders and laggers, and offers insights for navigating 2026.

Initial Expectations and the Shift in Market Sentiment

Following the US elections, the market initially reacted positively to the “red sweep” with US stocks rallying, Europe declining, and bonds selling off. Small-cap and cyclical stocks led the charge, the dollar appreciated, and cryptocurrency performed well. However, the unveiling of the Trump administration’s tariff policy triggered a significant shift from “risk-on” to “risk-off” mode, with “greed giving way to fear.” Many of the initial “Trump trades” failed to sustain their momentum. As Leovitz stated, “A lot of those so-called Trump trades really did not persist.”

Volatility in 2025: A Comparative Analysis

2025 proved more volatile than both 2024 and 2023, though less volatile than the particularly turbulent year of 2022, which was marked by inflation and aggressive interest rate hikes. The Morningstar US Market Index experienced significant daily swings, including losses of 5% on April 2nd and 3rd, followed by a remarkable 9% rebound when tariffs were paused – a daily move not seen since 2008. Despite this volatility, the US stock market achieved gains of nearly 18% by early December. Leovitz emphasized the positive outcome, stating, “I think we should be thankful for the gains that we've seen, but definitely a bumpy year.”

Sources of Volatility: A Multifaceted Landscape

Several factors contributed to the year’s volatility. Trade policy, particularly the implementation and adjustments to tariffs, was a primary driver. The launch of DeepSeek AI from China in January also rattled markets, challenging the prevailing narrative of US dominance in Artificial Intelligence. AI itself became a source of volatility, with concerns about valuations and the potential for an “AI bubble” fueling market uncertainty. Stretched valuations entering the year, coupled with economic data releases, the “big beautiful bill” and the threat of a government shutdown, further exacerbated market swings. Leovitz noted that US equity valuations were “priced for perfection” at the start of the year, setting the stage for potential disappointment.

Safe Havens During Down Periods

During periods of market decline, investors sought safety in bonds. The Morningstar US Core Bond Index maintained its value while equities experienced sharp sell-offs, fulfilling its role as a portfolio stabilizer. Within the US equity market, low-volatility stocks, exemplified by Berkshire Hathaway, also demonstrated resilience, acting as a “totem of the riskoff market vibe.”

Leaders and Laggers: A Surprising Outcome

A significant surprise of 2025 was the outperformance of international stocks relative to US stocks. While the US market gained almost 20%, the Morningstar Global ex-US Equity Index achieved even higher returns. Europe, Korea, Latin America, and China all experienced strong performance, boosted by the depreciation of the US dollar. Within the US market, large-cap stocks outperformed small-cap stocks. Technology stocks and sectors adjacent to technology, driven by AI, led the way, while utilities unexpectedly transformed into a growth area due to rising power demand from AI.

Investment Factors: The Rise of Momentum

Momentum emerged as the best-performing investment factor in the US equity market in 2025. Investing in recent winners proved to be a successful strategy, benefiting from the AI-driven market dynamics. However, momentum experienced periods of selling pressure, and other factors, like low volatility, saw temporary gains.

Shifting Leadership Throughout the Year

Market leadership was not static throughout 2025. Periods of volatility triggered rotations between factors, with low volatility benefiting during sell-offs and value stocks rallying in the fourth quarter as concerns about an AI bubble grew. Healthcare, a major underperformer for much of the year, also experienced a recent resurgence.

Looking Ahead to 2026: Key Areas to Watch

As of December 8th, 2025, Leovitz highlighted several areas for investors to monitor in 2026. The question of whether the market is in an AI bubble remains central. Investors should assess their AI exposure, recognizing that broad US stock market index funds may have significant, and potentially underestimated, holdings in AI-leveraged companies. He recommended considering exposure to value stocks, small-cap stocks, and international markets for diversification. Bonds are also seen as a potential source of both income and total return, but caution is advised regarding credit risk, given recent tremors in the credit markets and the influx of capital into private credit.

Key Takeaways for 2026

Leovitz emphasized three crucial takeaways for investors heading into 2026:

1. Market leadership is changeable: Leaders and laggers are dynamic, and past performance is not necessarily indicative of future results. The reversal of US exceptionalism in 2025 underscores this point.
2. Valuation matters: Valuation played a role in both volatility and international stock performance in 2025.
3. Diversification can pay off: Exposure to international markets, bonds, and even gold can help smooth portfolio returns and mitigate risk, particularly in an uncertain environment.

This year highlighted the importance of adaptability and a diversified approach to investment, acknowledging that market dynamics can shift rapidly and unexpectedly.