by Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company
My lines in the sand for 2026:
Line 1: Will we have a year 4 for this weaker-than-it looks cyclical bull? Earnings estimates say yes.
Line 2: concentration risk: zero sum or bullish broadening?
Line 3: Earnings are booming but the market is priced for it. EAFE has better value for the same fundamentals.
Line 4: Will the post-Powell Fed (in cahoots with the Treasury) run it hot in 2026?
Line 5: Will this cause a bear steepener, taking the wind out of the stock market’s sails?
Line 6: is Bitcoin entering another winter while gold takes a rest?
Line 7: will the gold and silver boom spill over into the broader commodity complex?
Let’s explore.
The state of the cycle
The current US economic expansion is now approaching its 6th year. It has been quite a ride, from pandemic to liquidity impulse to inflation to rising rates to political upheaval and now an AI boom and fiscal dominance.
There have been 30 business cycles since 1871 and if we measure the gain in the S&P 500 from the start of the current expansion, the cycle is well above average and eclipsed only by 2009-2020, 1991-2001, and 1982-1990.
Of course, we don’t measure bull and bear markets according to NBER-defined business cycles. In 2022 stocks fell 28% over 9 months, which qualifies as a bear market by any standard. We have been in a bull market ever since that low in October 2022, and both the cap-weighted and equal-weighted S&P 500 index are sitting at new all-time highs as of last Friday. The Mag 7 have obliterated the broader market, but only in relative terms.
Less than meets the eye
The chart below shows the current cyclical bull in inflation-adjusted terms. The cap-weighted S&P 500 price index is up 91% in nominal terms and 73% in real terms, and the equal-weighted index is up 52% nominal and 36% after inflation. That last number seems surprisingly low and shows just how much both the Mag 7 and inflation have masked what otherwise has been an unimpressive bull.
The baton has been passed
The current bull market began with P/E-multiple expansion, as is common given that price almost always bottoms before earnings. But in 2025 earnings have taken over as the dominant driver of returns, and this is good to see. Assuming that 2026 earnings materialize as expected, earnings and valuation are playing a roughly equal role at this point.
The 40-40-20 rule
This is good to see and in line with the typical cycle, where at this point (3 years in) earnings and valuation account for 40% of the gains each, with dividends contributing 20%. Below is the average for all bull markets since 1871. You can see how dominant valuation expansion is in the first year, followed by the baton-pass to earnings. Dividends are the steady support behind the two.
Earnings to the rescue
Earnings estimates have staged an impressive rebound from the tariff tantrum markdowns two quarters ago. We are poised to end the year where we started, and so far, 2026 appears to be lining up the same way.
Priced for success
But the market appears priced for this success. At the 12% earnings CAGR that is expected over the next 3-5 years, the market has an equity risk premium (ERP) of 4.2%. It’s richer than the average (5%), but it’s not out there. However, if earnings growth were to mean-revert back to its historical base line of 6-7%, the market would be 20% too high at the current ERP. The ERP would have to drop to a miniscule 3.2% for the math to add up. So that’s how I see the downside risk if earnings disappoint in 2026 and beyond.
CAPEX vs buybacks
One line in the sand I see for the coming few years is whether the relentless boom in CAPEX might cannibalize share buybacks. Per the chart below, the pie (sales) has been growing enough to accommodate both, but if that were to change in the arms race for AI dominance, a reduction in buybacks might hamper valuations, at a time when buybacks are on the rise in Europe and Japan.
Run it hot
With the Fed cutting rates a third time this year, all eyes are on who the next Fed Chair will be and how divided the FOMC will be in 2026. Judging by the dot plot below, the answer to the last question is “very.” Either way, the market is expecting short rates to fall to 3.2% next year, which is near the Fed’s long-term estimate of neutral. But that interpretation of neutral assumes 2% inflation (plus 1% R-Star), and on the inflation side we are still north of that with the core PCE growing at 2.8% and Truflation at 2.6%.
In this sense it’s worth remembering that the inflation dragon has not been slayed. It went from below 2% in 2019 to 9% in 2022 and has never gotten back to below 2%, which is where it needs to go for the long-term average to revert to 2%. Did you know that the 5-year rate of change in the core-PCE is 3.8% and rising? This is at the heart of the affordability crisis evident in the consumer confidence surveys.
With the Fed announcing $40b of T-Bills purchases (which I view as a reserve balance management tweak rather than QE), and the Treasury sitting on a $1 trillion pile of cash at the Fed (TGA), my guess is that the Treasury/Fed dynamic duo will be running things hot in 2026. The bid in commodities is part of this rising liquidity tide.
Bond vigilantes
The question is whether this “run it hot” strategy will lift the term premium and cause a bear steepening in the yield curve. In the Treasury market things have been eerily quiet since tariff tantrum days when all of us were wondering if foreign investors were going to sell (they didn’t), but other government bond markets have been feeling the heat. Below I show short rates on the left and long rates on the right. There are massive bear steepeners underway in Japan and Germany.
Will the US follow? If the US term premium were to continue rising (to say 150 bps), it’s easy to see the long end approach 5% again, as it has done a few times since 2022.
If so, the stock market is likely to take notice. With the risk-free rate yielding the same as the stock market, the Fed model is back. The Fed model is an indicator that compares the yield on Treasuries to the earnings yield on the S&P 500. If Treasury yields rise too far and fast, the stock market needs to reprice in order to remain competitive. This dynamic was not so important when yields were very low, but that is no longer the case.
My game plan for 2026:
The 60
The way I see it, the equity bull market is intact and appears poised to continue in 2026, propelled by capex and earnings. But the market is priced for this while there is significant concentration risk. What’s a possible solution? For me, paint the stock market with a global brush and hold a global equity basket rather than one that is US-centric. Below we see that earnings growth ex-US is now better than the US, while payout growth is competitive (at least for EAFE). It’s nice to have compelling alternatives to the Mag 7 when the S&P 500 is this top heavy.
The 40
Beyond equities, I don’t see much value in long Treasuries with yields near 4%. If the Treasury/Fed run it hot in 2026, the curve may well bear-steepen and the Fed model could kick in just as equity valuations are priced for success. For me that means fewer bonds and more uncorrelated alternatives. These include the various liquid alts (long/short, managed futures, etc) and also gold, Bitcoin, and commodities.
Gold, commodities, and Bitcoin
It has certainly been an interesting year for gold and Bitcoin. Gold mooned while Bitcoin swooned. Is it time for mean reversion? In my view, not yet.
Bitcoin
While I remain a secular bull on Bitcoin, my concern is that Bitcoin may well have ended another 4-year cycle halving phase, both in price and time. If we visually line up all the bull markets (green) we can see that the October high of $125k after 145 months of rallying fits pretty well with what one might expect. Bitcoin winters have lasted about a year, so my sense is that 2026 could be a “year off” (or “off year”) for Bitcoin. Support is at $65-75k.
Gold
As for gold, it’s consolidating in what I suspect is a bullish continuation pattern. It outgained the growth in the global money supply and its correction is appropriate, but gold’s ability to hold on to most of its gains by consolidating sideways instead of down has been impressive. That’s how bull markets behave.
Broader commodities
With gold consolidating and Bitcoin perhaps taking a gap year in 2026, where will we find an uncorrelated hard asset hedge? In my view, in the broader commodities complex. The chart below of the Bloomberg Commodity Spot index looks very constructive, and perhaps a good preview for next year.
Secular lines in the sand:
Line 1: Will the AI boom become a bubble?
Line 2: will the AI boom pay a productivity dividend for the SPX 493?
Line 3: Will concentration risk lead to a scarcity of beta, or can we have a bullish broadening?
Line 4: are long bonds impaired, and how do we hedge against that?
Line 5: will a less independent and more fractured Fed lead to a lower dollar and higher term premium?
Line 6: how sustainable is 2025’s “year of international equities”?
Line 7: will uncorrelated assets continue to be good diversifiers?
Possible remedy 1: international equities: a barbell against US concentration risk
Possible remedy 2: we need to hedge the 60 AND the 40: uncorrelated alpha.
2025: put a bow on it.
Here are we, near the end of the year and at the point that many of us check out from the markets to decompress and spend time with loved ones. It was a tense but good year for the markets, with the S&P 500 cap-weighted index gaining 18% so far and the equal-weighted index gaining 11%. The MSCI ACWI ex-US index is up 31%, and the Bloomberg Barclays US Agg is up a robust 7% YTD.
Cyclical leaderboard
For the cyclical bull market, which started in October 2022, the leaderboard is shown below. The chart is a bit unusual for it shows a scatter plot of the S&P 500 nominal return index on the horizontal axis vs the real return for the S&P 500 as well as 26 other indices on the vertical axis. It’s a handy way of visualizing who did what, and whether the inflation threshold was exceeded.
The S&P 500 has gained 87% in real terms over the past 167 weeks. Not bad at all, and this performance is only bested by gold, Ethereum, Bitcoin, and the Mighty Mag 7. It’s remarkable just how straight that Mag 7 line is, illustrating how outsized its Sharpe Ratio has been. At the bottom are commodities and Treasuries, as well as managed futures, which took a beating last spring as the market whipsawed from a 21% loss in April to new all-time highs just a few short weeks later.
The secular leaderboard
If we take this chart concept back to March of 2009 (which in my view was the start of the current secular bull market), we get the chart below. The S&P 500 is up 9-fold in real terms, and it has crushed every asset on the planet with the exception of Bitcoin and the Mag 7 (which morphed out of the FANGs in 2022 or so).
The AI question
The bubble question remains the one that is most often asked of me (and probably everyone else), and my belief continues to be that we are not (yet) in a bubble. There are parallels to the late 1990’s, but some of the more extreme conditions back then are simply not present yet today.
I am increasingly of the view that an AI bubble may not be likely. This is not only because everyone is asking the bubble question, but also because the recent market action shows that there is a healthy amount of scrutiny with regards to the unproven AI names and even the proven ones. Investors are asking the right questions about circular vendor financing and the zero-sum winner-take-all race for AI supremacy.
Of course, the Time person of the year curse doesn’t help, but it’s somewhat offset by the market’s skepticism. Finally, as the chart shows below, the Mag 7 have continued to be fueled by robust earnings growth. Their 4x gain since late 2022 is mostly supported by earnings. That’s not to say they are cheap, which at 39x earnings they are not. But back in 1999 stock prices were fueled entirely by valuation gains, and that is not the case today.
Downstream dividends
A big question is whether the rest of the market will reap the benefits of the “rails” that are currently being laid by the Mag 7. The chart below shows the S&P 493 and their earnings squiggles. They are indeed accelerating, but I’m not sure whether that’s from the OBBBA or the AI revolution. Perhaps both. But at least they have been moving in the right direction.
Concentration risk
But how big is too big for the AI trade? At what point do we have a market that goes up and down only because that’s what the Mag 7 are doing, and not because the majority of stocks are advancing? History suggests that we are already there. First of all, the tech and communication services sectors alone already count for as much as those sectors did back in 2000. And that’s not including other sectors in which the Mag 7 dwell (e.g., Amazon).
And history is clear that when the Nifty 50 stocks go down, the index goes down.
The cresting long wave
Which brings me to the long wave and when (and if and how) it will eventually end. Looking at the 1949-1968 and 1982-2000 secular bull markets, this one appears to be in its final innings.
CAPE model: less beta ahead
The above notion is supported by the CAPE model, which suggest that the market’s “slope” may start to flatten out in the next few years. It suggests not decline, but an advance at a below-average pace instead of above-average.
Nifty slope
If the secular slope flattens out, it suggests (to me at least) that the Mag 7 might no longer be as mighty in the future. But would gladly be proven wrong on that front and be convinced that the market can bullishly broaden even if no longer supported by the excess returns of the Nifty Fifty.
Margins and valuation
A flattening slope in the future also suggests that the margin expansion wave might slow down in the coming years. The margin and P/E-expansion themes are inextricably linked.
Financial engineering
Another driver behind the outsized returns since 2009 has been the supply and demand of shares. While IPOs and secondaries have amounted to $3 trillion over the past 16 years, share buybacks and M&A have offset that by a factor of 7 to 1.
Revenge of the term premium?
While financial engineering and margin expansion have been big drivers of valuations, so have interest rates, at least until they reset in 2022. In my view, the direction of the term premium on US long Treasuries will be an important driver for US equity valuations going forward now that equity valuations are rich.
Fiscal dominance
Will fiscal dominance drive the term premium higher and force a potentially fragmented Fed to engage in financial repression? I think the answer is “likely,” unless the Fed can steepen the curve and deregulate the banks enough to have the banks do the work for it. According to the CBO, in the coming few years the 5-year CAGR of potential GDP will fall below what I see as fair value for the 10-year Treasury yield. If that happens, the US debt burden will become unsustainable and require yield curve control.
For now, the market expects the Fed to ease towards 3%, which at an inflation rate of 2.5% would be below R*. That would be an accommodative policy stance at a time when the economy might be running hot.
If the Fed were to be “flipped,” while the US economy runs above potential and fiscal deficits continue to loom large, that should put upward pressure on the term premium. To me that spells “bear steepener,” which makes long Treasuries unattractive near 4%.
Remedies
How do we address concentration risk and a potentially rising term premium over the coming 3-5 years? For me a possible approach is two-fold: diverse the equity bucket towards global equities, and protect not only against the 60 but also (especially) against the 40. The chart below shows the three buckets of asset classes: equity-like, bond-like, and none-of-the-above. That’s a good place to start in my view.
I continue to view the 60/40 as yesterday’s news and the 60/20/20 as a diversification model of the present and future. Take 20 out of the 40 and sprinkle in a bunch of other stuff that’s uncorrelated to both equities and bonds.
For equities, the MSCI EAFE index is an example of a diversifying index. Companies in Europe and Japan have gotten the share buyback religion and their “net issuance” has been declining even faster than in the US. That has produced a higher payout ratio which at a steep valuation discount has helped make non-US developed markets competitive again.
As for the 40, I continue to be a superfan of gold and Bitcoin, but I suspect that both of them may take a year off before potentially dominating the scene once again. As the chart shows below, gold has only just started what could be another super cycle against equities.
And perhaps 2026 and beyond will finally bring the broader commodity complex into the game. The Bloomberg Commodity Spot index is finally on the move again. Commodities are the ultimate diversifier against both stocks and bonds, but their alpha delivery tends to be sporadic.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.Copyright © Fidelity Management & Research Company
