Good morning investors,
I hope all my readers had a wonderful Christmas period. As we enter the final trading days of 2025, the S&P 500 sits at record highs near 6,930 after gaining 2.3% last week, perfectly positioned for a positive Santa Claus rally conclusion. Consumer confidence hit multi-year lows in December despite markets reaching fresh peaks, highlighting the K-shaped economy's persistence where affluent investors thrive while average households struggle. Looking ahead to 2026, I'm publishing my comprehensive outlook today targeting 10% S&P gains with 10-20% intra-year volatility - the full analysis is available here - 2026 Market Outlook
Opening Bell: Records Meet Reality
S&P ($SPY ( ▲ 0.07% )) futures down 0.2% with Nasdaq ($QQQ ( ▲ 0.21% )) futures off 0.4% while Dow ($DIA ( ▲ 0.12% )) futures hover flat. Nvidia, Micron, and Oracle each fall over 1% premarket after last week's AI rally with gains of 5%, 7%, and 3% respectively. DigitalBridge soars 50% on reports SoftBank nears acquisition, highlighting insatiable data center infrastructure demand.
The S&P hit intraday high of 6,945.77 Friday before closing just below breakeven, capping 18% gains for 2025. The Dow's 14.5% marks its best year since 2021 while the Nasdaq's 22% outperformance validates technology leadership despite rotation fears.
2026 Outlook: Resilience Through Volatility
My full 2026 outlook projects approximately 10% S&P gains, though the path won't be smooth. I expect heightened volatility with potential 10-20% intra year drawdowns, particularly in the first half as midterm election dynamics intensify. Since 1970, midterm years averaged 16% volatility versus 13% in other years with typical 19% peak to trough declines.
The constructive thesis rests on AI's multi-year expansion, accommodative Fed policy despite sticky inflation, and 15% earnings growth driven by operating leverage and volume recovery. The market's post-COVID resilience, rebounding from supply shocks, rate hikes, and banking stress, suggests pullbacks create tactical buying opportunities rather than structural breaks.
Midterm Election Dynamics
History provides compelling context for 2026's volatility. The S&P 500 hasn't declined in the 12 months following a midterm election since 1946, averaging 15% gains versus 7% in non-midterm years. From midterm year bottoms, the average subsequent twelve month gain reaches 32%.
Expect maximum uncertainty in Q3 as political rhetoric peaks, creating hedging opportunities before potential year-end rally. Divided government outcome would be ideal, limiting sweeping policy changes and fostering stability that markets crave.
Consumer Confidence Disconnect
December's Conference Board confidence fell to near four year lows, marking five straight monthly declines despite record stock prices. This disconnect between sentiment and asset prices perfectly captures the K-shaped recovery where stock owning households thrive while wage earners struggle.
Yet consumer spending continues beating expectations with 2025 holiday shopping smashing records. The surveys may simply reflect a ceiling on reported optimism rather than actual economic stress. Since 2020, equity prices compounded sharply while confidence remained structurally depressed - markets no longer need household mood validation.
Sector Positioning for 2026
Overweight: Financials (especially regionals benefiting from steeper yield curves), Utilities (nuclear resurgence for AI power needs), Industrials (infrastructure and electrification plays)
Core Holdings: Technology and AI remain multi-year drivers despite bubble concerns. Cybersecurity and quantum computing emerge as next-wave beneficiaries. Use pullbacks as entry points, not exits.
Tactical Opportunities: European equities offer compelling valuations at substantial P/E discounts to US markets. Consider international diversification in H1 before rotating back to US growth as AI monetization clarifies.
Digital Assets Renaissance
Bitcoin poised to reclaim $100,000 in 2026 driven by regulatory clarity and institutional adoption. Ethereum could see meaningful early year appreciation while Solana targets a recovery to $200. Major exchange operators stand out as ecosystem winners leveraging trading volumes. Maintain 5% portfolio allocation for asymmetric upside.
Fed and Policy Outlook
Expect approximately 50 basis points of cuts in H1 2026 as labor market softness prompts dovish tilt despite sticky inflation. The yield curve should steepen with short rates falling faster, benefiting financials and homebuilders. Powell's legacy hinges on maintaining independence while supporting growth, the 'Fed put' remains intact.
Wednesday's FOMC minutes provide final 2025 insight into committee thinking. With 80% odds of January hold, markets expect continued wait and see approach balancing employment concerns against inflation persistence.
Final Thought
We close 2025 with markets demonstrating remarkable resilience, the S&P up 18%, Dow posting best year since 2021, and Nasdaq gaining 22% despite persistent negativity. This divergence between price action and sentiment captures modern market dynamics where liquidity and earnings matter more than mood.
My 2026 outlook embraces volatility as opportunity rather than threat. The 10% gain projection with 10-20% drawdowns reflects historical midterm patterns where corrections create tactical entry points before powerful recoveries. The market's post-COVID psychology, sharper declines but quicker V-shaped recoveries, rewards patience and preparation.
Key themes for 2026: AI expansion beyond hardware into applications, Fed accommodation despite inflation, rotation favoring early-cycle plays, and international diversification windows. Small caps could finally outperform after years of lagging, while nuclear energy emerges as unexpected winner from AI's power demands.
The Santa Claus rally's conclusion this week sets 2026's tone. Historical patterns suggest positive momentum continues, but prepare for choppier waters ahead. Maintain quality core holdings, use pullbacks to add exposure, and stay nimble as macro pictures evolve.
For my complete 2026 outlook including detailed sector analysis, risk scenarios, and portfolio positioning recommendations, please visit Here.
Wishing all readers a prosperous New Year ahead.
As always, feel free to reach out with questions about 2026 positioning.
Best regards,
Dan Sheehan
This newsletter is for informational purposes only and should not be considered as investment advice. Please consult with your financial advisor about your specific situation.