Profitability expands as policy uncertainty fades

Markets reflected remarkable calm through most of 2025 despite a sweeping shift by the new administration across the government sector, trade, fiscal, tax and monetary policy. The severe April selloff was an exception to the calm, but proved brief, with markets recovering and rallying for six consecutive months, virtually uninterrupted with only minor pullbacks.

Our central belief is that 2026 will be a reboot—and continuation—of the resilient expansion we experienced in 2025. Today, we see resilient but uneven economic growth—characterized by a “K-shaped” economy that looks different depending on one’s industry, job or income level.

Markets absorb policy volatility

Aside from April’s swoon, markets were steady amid heavy policy churn. Policymakers briefly caused investors to question the economic clarity that was apparent at the beginning of 2025, yet growth proved to be durable—a testament to the structural resilience that continues years after the post-pandemic era.

Tariffs had the potential to be the most disruptive policy tool given their broad implications across trade, economic activity, input costs, consumer inflation and corporate earnings—not to mention monetary policy. Yet as policy evolved, their effects on consumers and corporations have thus far proved manageable—offset by fiscal and tax stimulus from the One Big Beautiful Bill Act, Federal Reserve (Fed) rate cuts and substantial AI-related capital spending.

As always, inflation and corporate earnings mattered most. Earnings performed well in both absolute terms and relative to expectations, which was enough to propel equities to double-digit gains in the U.S. and abroad. Worst-case inflation expectations did not materialize, and fixed income had one of its best overall years since 2020.

Exhibit 1: Healthy earnings and improving inflation helped investors look past policy uncertainty

January 1, 2025 to November 24, 2025. Source: Bloomberg

Turning the page on sound footing

Major risks—from tariffs, political gridlock and inflation—proved less severe than they might’ve been. This better-than-expected outcome allowed the Fed to resume rate cuts and investors to look past policy uncertainty.

With no immediate fallout, fundamentals like corporate earnings, capital investment and productivity again drove returns.

To sum it up, markets have demonstrated an ability to digest policy uncertainty and come out stronger on the other side thanks to healthy economic and corporate fundamentals.

Durability may be tested in a divided economy

The path ahead will have a few defining characteristics, and we believe the increasingly apparent K-shaped tale of two economies will have an important bearing on markets in 2026.

A divergence between upper- and lower-income Americans has been intensified by the “wealth effect” as investment gains have increasingly accrued to the top. At the same time, wage growth gains have slowed, particularly for lower income workers, who also have less cushion against affordability pressures as prices remain high even as the inflation rate normalizes.

Beyond big tech: Earnings growth widens

Strong corporate earnings growth remains a bright spot as it broadens to include greater participation. The largest U.S. firms remain structural drivers of the economy through their share of capital investment and the role that AI already plays in reshaping work habits. Investors are familiar with the outsized contributions to earnings growth, market performance and high valuations from these leading tech companies. This has been the status quo for several years, so we suspect investors may be more impressed by accelerating earnings growth in the rest of the market.

We often hear that market valuations are expensive, and they are, but the largest stocks contribute an outsized share of that richness while the rest of the market trades at more justifiable valuations. The latter group has also been increasing contributors to earnings growth, so they may be greater participants in positive performance in 2026.

Exhibit 2: Contribution to S&P 500 earnings has broadened in 2025