Maturing bull market faces some early tests to begin 2026
Bull markets are almost never cut short by geopolitical flareups, in case anyone is wondering. More often they are treated either as exacerbating factors to an already-weak trend (the 9/11 attacks, the 2022 invasion of Ukraine), clarifying moments that boost risk markets (Battle of Midway in 1942, the U.S. invasion of Iraq in 2003) or mere noise that can safely be tuned out (last year’s U.S. attack in Iranian nuclear sites). The weekend capture by the U.S. of Venezuelan President Nicolas Maduro would be more likely to act as an excuse for the financial markets to tense up if stocks had barreled into 2026 at an exuberant sprint rather than shuffling indecisively around the same index levels first encountered more than two months ago. If oil typically acts as the transmission mechanism to the equity market from international conflict, crude’s current benign level and the fact that energy now represents a narrow sliver of the typical household budget suggest the stakes for the economy are not particularly high around any prices swings. .SPX 1Y mountain S & P 500, 1 year Foreboding conjecture about what comes next and whether U.S. action will cause ruptures with allies or further instability in the region is relevant to the world at large, of course. But when it comes to such issues’ proximate impact on investors, it always makes sense to ask, “What specifically should markets be repricing today based on these events?” In the absence of an immediate trigger for fundamental re-evaluation or redirection of fund flows coming out of the weekend’s unanticipated events, the answer is probably “not much.” Broadening market? Which leaves us with a more routine set of questions for the market in the first full week of the year. Such as what we ought to make of the S & P 500’s slightly soft finish to 2025, what the two-month trading range is telling us and how expectations are arranged for the coming year. The index slipped 1% last week, failed to extend its monthly win streak to eight and sits now at a level first reached on Oct. 24. Aside from disappointing any misguided traders who care about the Santa Claus Rally period (which ends Monday with the S & P needed to rise 0.9% to avert a third straight decline over this span), the indifferent action has muted short-term trader optimism without undercutting a broadly held optimistic consensus. The rotational dynamics since late October have continued to favor economically sensitive stocks and 2025 laggards over the tech giants that contributed the most value over the past three years. With the S & P 500 down a smidge from Oct. 29, the index’s equal-weighted version is up more than 1%, transportation stocks are up 6%, financials ahead by 3% and the tech sector off 4%. This is what the “broadening market” that so many observers predict and seems to want looks like. An upbeat implied macro message given the cyclical leadership but nothing special for passive index holders or for the aggregate wealth of equity owners. This is an AI-propelled, mega-cap-tech-led bull market and bull markets tend not to see leadership transfer to an entire new category of companies three years in while still maintaining upside thrust. But periods of harmonic rotation away from tech have refreshed the uptrend several times. And, who knows, this is a bull market that began in unprecedented fashion while the Fed was still tightening, so never say never, I guess. Two and three months ago, Wall Street was captivated by another stellar earnings season, a Federal Reserve resuming rate cuts into a steady economy and constant ecstatic new projections for AI spending. In late September, surveying this bounty of bullish factors, I asked, “What do you get for the market that already has everything?” At the time, investors were understandably looking ahead to an all-inclusive fourth-quarter ramp, which probably would have tripped into excessive optimism and heedless speculation. Instead, the market has worked to rebalance itself somewhat. Showing little propulsive momentum at the index level and under the sway of wide dispersion among stocks and sectors, this churning phase has left investor positioning and attitudes shy of dangerous extremes. Mag 7’s struggles Jonathan Krinsky, BTIG’s technical strategist, flagged that the Magnificent 7 were down each of the past five days, even with semiconductor stocks ripping on Friday, which he says has generally led to a good tactical bounce in the group over the past couple of years. The variance in performance among the Mag 7 – Meta in the penalty box, Alphabet the new darling, Microsoft shares apparently suffering as a proxy for doubts about OpenAI’s ambitions, Nvidia dead money for months as its valuation compresses – has surely been a welcome counterpoint to the AI bubble talk so prevalent a few months ago. The daily equity put/call ratio rising to a multi-month high on Dec. 31 – not a compelling buy signal for stocks but evidence that the market is a bit more hedged and ambivalent than the universally bullish brokerage-house projections would imply. While a small sample size, the historical record for what happens after the S & P 500 has a down month after a seven-month win streak is more reassuring than alarming for the near term. Numbers compiled by Nerad + Deppe Wealth Management show that after the six prior such streaks ended, the index was higher over the next few months each time. Still, twice this seven-up/one-down monthly pattern preceded a bear market within a year’s time – including when it occurred in September 2021. A few notable things about the unanimously positive outlook among the dozen or so strategists at the big shops. First is that the upbeat thesis is fully rational and plausible. Stocks gain about three of every four calendar years. Earnings forecasts continue to rise, the Fed is at least leaning toward additional rate cuts and early 2026 will see some fiscal lift from higher tax refunds and lower withholding rates. Second, though, is the degree to which the market handicappers are taking the consensus 13% S & P 500 profit growth largely at face value, not allowing for the common pattern of estimate erosion. And, more pointedly, almost no one is taking issue with valuations sitting near historic highs, the S & P forward price/earnings ratio above 22. Most everyone’s leaning on the line that P/E ratios are poor timing tools, companies have more resilient business models today than in the past and valuation rarely gets in the way when profits are rising and the Fed not tightening. I’m here not to pick a fight with this rationale (rationalization?), but simply to note how widely it’s shared. Valuation reflects embedded expectations, so a more expensive market should be tougher to impress. We’ll see if that’s the case.
<
