Equity markets maintained a positive bias during Q4 with the S&P500 rising 2.3% for the quarter and finishing up 17.9% for 2025. Fixed income returns also continued to rise during Q4 pushing the Aggregate Bond Index return above 7% for the year. Investors have benefited from the moderate declines in interest rates across the yield curve, stronger than expected earnings and economic fundamentals, and inflation trends that moved in the right direction (lower) during the year.
Entering the 4th year of the current bull market with equity valuations stretched, our focus is to balance our clients’ needs for long-term growth with the disciplines of downside protection. Our focus for 2026 will be on the fundamental drivers of investment returns – interest rates and earnings (free cash flow). We will evaluate extraordinary global events by their expected impact on these fundamentals.
Currently, consumer sentiment is already near 50-year lows and has been holding below the 50-year average since before Covid. Although valuations seem high, there is an inherent Wall of Worry built into equity prices that indicates to us the markets are not in a bubble. In fact, earnings fundamentals are strong and expected to improve in 2026. Most equity market strategists expect earnings growth for 2026 to be above 10%. Even the Fed has recently raised their expectations for 2026 GDP growth. Companies will begin providing their forecasts for 2026 with their Q4 earnings reports shortly.
A stronger than expected economy may hold inflation higher and keep interest rates higher than expected – which would be negative for equity valuations but good for earnings. Fiscal imprudence could also hold interest rates higher. A weaker than expected economy may cause earnings to disappoint. Our expectation for 2026 is middle-of-the-road and calls for equity returns to approach earnings growth near 10%.
Longer term, we remain bullish on equities based on three fundamental drivers: artificial intelligence (AI), the onshoring/expansion of the US industrial manufacturing base, and the secular growth in productivity that results.
2026 will be an important year for the AI economy. AI services need to catch hold with businesses willing to pay for it; or future infrastructure spending will be pared back and have a negative impact on related businesses.
Domestic manufacturing has been weak for decades and there is a real opportunity to expand our capacity with state-of-the-art capabilities not only supporting our own needs but making the US more competitive globally as well. This has been in the works but will start to have an accelerating impact going forward.
Finally, the growth in productivity that is expected over the next several years should promote economic growth, lower inflationary pressures, and lift overall living standards going forward.
We wish to extend our appreciation to all our clients for their continuing support; and would like to wish everyone a very happy and prosperous new year.
Disclosure Statement
SFE Investment Counsel is a Registered Investment Adviser. This presentation is solely for informational purposes and not a solicitation to invest. The results reflect thededuction of fees and the reinvestment of dividends and other earnings. Advisory services are only offered to clients or prospective clients where SFE and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by SFE unless a client service agreement is in place. Please contact a financial advisory professional before making any investment.
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