Portfolio Insights & Outlook Q1 2026

2025: YEAR-IN-REVIEW

Global equity markets exhibited another year of strong returns, but volatility returned to the forefront as global trade partnerships were redefined. The S&P 500 index, a collection of the largest stocks in the U.S., declined 18.9% from February through April in concert with falling earnings estimates brought on by heightened anxiety. Eventually, curtailed trade rhetoric slowed the freefall of earnings and brought upon a reversion back to normalcy. Markets hate uncertainty but only hate weakness in earnings more. From the low set on April 8th through the end of the year, the S&P 500 returned 37.4%, finishing the year up 17.9%.

Equity Markets - Annualized Return

Unlike previous years, U.S. markets were not the standout, the crown went to international stocks, particularly emerging market stocks. The MSCI ACWI ex USA index, a representation of international stocks, advanced 33.2% in 2025 with international developed stocks up 32.7% and emerging market stocks advancing 34.3%.

U.S. Dollar Declined Quickly on Economic Uncertainty at the Beginning of 2025

There were a couple of reasons for this shift in market leadership: U.S. dollar and better fundamentals. The Bloomberg dollar index, a weighted average of exchange rates between U.S. dollar and major world currencies, declined -8.1% in 2025. One of the main reasons for the decline in the dollar was a global rebalance from expensive U.S. assets. As for better international stock fundamentals, emerging markets have exhibited massive positive 2026 earnings revisions that sparked renewed enthusiasm for this forgotten asset class. Positively, most emerging market industries across the board have contributed to the earnings upside, including materials, healthcare and technology. Growing demand for technology has had global repercussions, especially since emerging markets tend to have more similarities to U.S. markets.

U.S. ECONOMIC SURPRISES

The improvement in economic data as 2026 kicks off has been palpable. The Citi Economic Surprise Index, a gauge of how economic data compared to market consensus expectations, was at positive levels (economic data surprising to the upside) for most of the back half of 2025 and spiked to the highest level since 2023. One of the largest contributors to the upside was the once stagnant U.S. manufacturing activity. The ISM Manufacturing PMI (shows the health of the manufacturing sector) recovered from a state of contraction to a level of 52.6 in January 2026 (the highest level since the end of 2022). Many of the headwinds from trade policy are becoming a thing of the past, giving businesses more clarity to plan moving forward.

Although, one of the segments of the economy stuck in the doldrums has been the labor market. From May 2025 through December 2025, only 11,000 jobs were added on average per month. The prominent reasons for the weak job growth have been general uncertainty from Corporate America leadership, which has led to a “no fire, no hire” environment. Despite the general unease emanating from the labor market, consumers have been resilient. Coupled with a tight labor market and positive disposable income, consumers have been able to keep spending and supporting economic activity that has trended near average levels.

SIGNS OF PRODUCTIVITY?

The key differentiator for U.S. economic activity has been a resurgence in productivity. In the third quarter last year, output per hour worked (productivity growth) rose to a quarter-over-quarter rate of 4.9%, as output increased 5.4% and hours worked increased 0.5%, while the prior quarter’s rate was revised up from 3.3% to 4.1%, again driven by a massive move higher in output. However, the recent rise in productivity has been out of the ordinary dating back all the way to the ‘90s. Productivity booms in the 1960s and 1990s saw average productivity growth of 3.3% and 3.1%, respectively. This compares to the long-term median, post-great financial crisis and of the 1970s that exhibited productivity growth of less than 2%.

U.S. Nonfarm Productivity

This was the fastest QoQ seasonally adjusted annual rate (SAAR) increase in productivity in two years (Q3 2023, 5.2%).

Productivity momentum has surged largely because of spending on growth-enhancing technology. The “Magnificent 7” companies, which includes, Microsoft, Amazon, Alphabet, Meta, Apple, Nvidia, and Tesla, are projected to spend over $500 billion on capital expenditures in 2026. To put this number in perspective, 2% of economic growth is being spent by just seven companies with most expenditures focused on powering and constructing data centers.

The benefit of a productivity boom is the resulting inflation-less economic activity. As of the last couple of months, inflation has risen to a 2.7% level but has inched closer to the Federal Reserve’s preferred rate of 2%. Even incoming Federal Reserve Chairman Kevin Warsh has noted one of the clear benefits of productivity is the propensity for lower rates. It is unclear whether higher productivity should lower the overall level of rates, but the important implication is the effect on sustainable growth.

FOLLOW THE LEADER? VALUE AND SMALL-CAP STOCKS EXHIBITING MOMENTUM

Two segments of the stock market that perform relatively best during periods of economic expansion include value and small-cap stocks. The composition of both markets is the main explanation for this performance. While technology remains the largest sector in the large-cap value segment, other significantly weighted sectors include financials, industrials, and energy. Similar to large-cap value, two of the largest small-cap sectors include financials and industrials.

Due to the similarities of large-cap value and small-cap stocks, they also share similar characteristics in respect to valuation. Relative to the overall large-cap index, large-cap value trades at a 10% discount to its historical average, while small-cap stocks trade at a nearly 30% discount to the long-term average. Buying equities at longer-term valuation discounts can be indicative of a better potential return, however a fundamental catalyst is necessary for valuations to normalize.

The fundamental catalysts for both markets rely on upside economic growth. For instance, with the financials sector being a significantly weighted sector, the earnings variability tends to swing the overall sector. Financials perform best as lending opportunities improve alongside the economy and rising interest rates. Consequently, this willingness to lend more likely underpins the capacity for greater capital expenditures that reinforces industrials’ earnings power. Industrials are realizing massive orders for building data centers, power generation, etc.

A shift in the economic climate that favors growing the economic capacity is already showing up in earnings expectations of small-caps and value stocks. First, the highest weighted stocks in the S&P 500 are expected to see their earnings growth converge with the rest of the market. By the end of 2026 and into 2027, the earnings growth of both segments should only see a 2-3% difference in earnings growth, which should turn the attention of investors from the largest growth stocks to the rest of the market. Investors will be able to purchase stocks with similar growth characteristics without paying too much. The same can be noted with small-cap stocks, with its earnings growth over the next eight quarters expected to outpace large-cap stocks by a significant amount.

S&P 500 Index Earnings Are Broadening

S&P 493 and Magnificent 7 fundamental picture converging 

A broadening out of earnings from a concentrated few stocks spells many benefits for market return longevity. No longer should the market rely on a handful of stocks to not only carry earnings, but performance as a result. Looking ahead, the foundation for equity investors is becoming stronger as economic growth firms, productivity rises, and risk sentiment remains strong.

 

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