High Valuations, Higher Stakes: We’re Expecting Volatile Markets in 2026

Susan Dziubinski: Hello, and welcome to Morningstar’s first-quarter 2026 US Stock Market Outlook. My name is Susan Dziubinski, and I’m the co-host of The Morning Filter podcast. Now, 2025 was certainly a volatile year for investors. Worries about DeepSeek in January and tariffs in April drove down stocks, yet the AI trade ultimately won out, lifting US stocks to a third straight year of double-digit gains. Are we likely to see another year of double-digit stock market gains in 2026? How about more volatility? And what risks should investors prepare for in the year ahead? Here to share their outlooks for the stock market and the economy are Morningstar’s Chief US Market Strategist Dave Sekera and Chief US Economist Preston Caldwell. Let’s begin. Dave, over to you.

David Sekera: All right. Thank you, Susan. And thank you to everyone for joining us today. Now, before I get into the slide deck and the main part of our webinar, I do want to explain the title of our 2026 outlook: “High Valuations, Higher Stakes: Expecting a Volatile 2026.” Now, in my opinion, trying to predict where the S&P 500 is going to end in any one individual year, to some degree, or actually even to a large degree, I think, is a bit of a fool’s errand. As long-term investors, what we look to are valuations, to be able to help investors to be able to ride out downturns as undervalued stocks should hold up better to the downside, whereas overvalued stocks will fall further and faster than the market, but then also still be able to participate to the upside, as undervalued stocks will outperform in a rising market, and overvalued stocks will end up lagging. When I’m thinking about volatility in 2026, I suspect it’s actually going to be a lot higher over the course of the full year of 2026 than what we saw in 2025. A lot of volatility in the beginning of 2025, but for the most part, in the second half of the year, it’s just mostly up and to the right. A couple of hiccups here and there, but really not as much volatility as I think we’re going to see over the course of this full year. And as we go into the slide deck, I’ll review a number of those key highlights that we’re watching that could drive that volatility.

Now, one thing I do want to point out is that it’s not just volatility to the downside, which is usually how most people think about volatility. I think there’s also a lot of volatility to the upside as well. So, when I’m thinking about the AI trade, I just want to highlight Taiwan Semi TSM. Taiwan Semi came out with earnings. We reviewed our financial model, and our analyst just put out a note in which he increased our fair value by 42%. Now, this is a stock that, since 2022, much of the time, was either a 4- or 5-star-rated stock. The market caught up to our fair value at the end of last year. But following that guidance that they provided, which now has multiyear guidance out to 2029 that was higher than what we initially had in our model, we increased that fair value. Stock’s up 7% this morning, but it’s still 18% below our fair value at this point in time. I think the takeaway here is that while valuations are very high, certainly subject to swift and severe selloffs for those stocks that disappoint, as much as I see that risk of the downside, I think there are also very significant risks to the upside over the course of this year as well.

Let’s go ahead and get into our slide deck here. So, first of all, I will just start off with our typical review of the US equity market evaluation, highlight our sector valuations as well, and then talk about valuation by economic moat. I’ll quickly review mega caps, and you’ll hear me talk about this a lot during this presentation. As much as we’ve talked about mega caps in the stock and how they skew the broad market valuation and valuations of individual sectors, styles, and capitalizations, they’re doing more so even today. I’ll turn it over to Preston to provide his US economic outlook. I’ll quickly wrap things up with a fixed-income outlook, and as Susan mentioned, we’ll get to as much Q&A as we can.

So, where are we today? Coming into the year, as of Dec. 31, the US market was trading at a price/fair value of 0.96, so indicating the market was trading at a 4% discount. For those of you who haven’t watched our webinars in the past, just to quickly review how we come up with our fair value for the market. Morningstar’s equity research team covers over 1,600 companies globally, of which over 700 trade on US exchanges. And, of course, we cover the largest, most liquid of those stocks as well. So, pretty much a very high percentage of the overall market capitalization. We put together a composite of the intrinsic valuation on all of those stocks as covered by our equity analysts. And we compare that to the market capitalization of all of those stocks. So, really, truly a bottom-up valuation analysis based on our fundamentals, whereas a lot of other strategists typically come with more of a top-down approach. They usually have some sort of model, sort of algorithm to come up with what they think S&P 500 earnings are going to be. They slap some sort of forward multiple on it, and it always seems like they’re telling you the market’s 8% to 10% undervalued. In my view, that really always seems to be much more like goal-seeking than it is necessarily a true valuation analysis. We break our valuations down by the Morningstar Style Box.

Now, in this case, you can see small-cap stocks are still very attractive, trading at a 15%, which is actually a similar discount to where we came into the year last year at this point in time. Now, last year, we had noted that we thought that small caps probably wouldn’t outperform until the second half, or even until late 2025, which is what we saw come to fruition, and we’ll talk about a couple of reasons why. I do think that with what’s going on in the marketplace today and what we’re seeing, both economically as well and some of the macro dynamics, and having seen small caps outperform in November and December, I think this year might be the year that small caps finally start catching back up to the broader market valuation and is a good time to be overweight those stocks. The other thing I have to note is that we made very significant value increases over the course of the fourth quarter. And when you put those into our model, that’s why you see growth. Stocks are now trading at a 10% discount, whereas they had been trading at much closer, even above fair value in the past. But that discount is highly concentrated.

In the growth category, if you were to exclude our valuations for Nvidia NVDA and Broadcom AVGO, growth stocks would actually be trading at a 4% premium. So, again, getting back to how much mega-cap stocks and their valuations can skew the category. That’s evident here in that growth category, and we see those two stocks specifically really driving the largest part of the discount for the growth category. Another thing we’re going to talk about a little bit over the course of the webinar is how to position your portfolio for the year. In this case, while the growth category in and of itself is undervalued, and we do see both Nvidia and Broadcom being 4-star-rated stocks, it’s not all of the growth stocks. And in fact, what I think is you need to position that you need to position your portfolio. You still want to take advantage of upside in artificial intelligence, but yet steer clear of those technology stocks that are more commodity-oriented. For example, with Nvidia and Broadcom, both of these are companies that have long-term, durable competitive advantages. They’re at the forefront of the technology for the semiconductors and the GPUs that they manufacture. Whereas other stocks that have rallied and rallied quite significantly over the past couple weeks or months, many of them are more commodity-oriented technology companies.

For example, Micron MU is one where we also have increased our fair value, but the market has run way up higher than we think is warranted for the long-term intrinsic value of that company. Micron, when you think about what they do, they make memory chips. We think that’s a commodity-oriented product. While they’ve been selling everything and anything they can, they’ve been able to increase their prices. They’ve been able to increase their margins here in the short term. With the AI buildout boom, everyone is buying as much and everything that they can. We expect that over the next year and a half to two years, more supply will come online. As that supply comes online for memory chips, we’d expect that even if they’re selling more chips, the revenue for those chips probably declines. And margins come down as well. So, I’d expect earnings over the next couple of years, while they look great here in the short term, would end up coming down in 2028 and beyond. Top-line perspective and the margin perspective, bringing earnings down, which, of course, then will certainly hit the stock at that point in time.

Just taking a quick look at our valuations over the course of the past 15 years, going back to the beginning of 2011, you can see where our valuations have bottomed out during specific catalysts over time, where our valuations have run too high. For example, at the beginning of 2022, the market was trading at a 6% premium. We were recommending investors to be underweight equities at that point in time. There are a number of different macro dynamic factors we had highlighted as well. We’re expecting inflation to increase, monetary policy to tighten, the economy to slow, and so forth. Of course, the market does what it always does. Not only did it sell off, but it sold off way too far to the downside, at which point in time, we advocated investors to start overweighting stocks in the fall of 2022. And over the course of the next year and a half, rallied right back up as to where we got back to above fair value and now seeing fair value trading at that 4% discount. So, from the broad market perspective, again highlighting how mega-cap stocks are skewing that broad market valuation, if you were to strip Nvidia’s valuation out of that price/fair value metric, that would bring our price/fair value to 0.98, only a 2% discount. And from there, if we were to strip out Alphabet GOOGL and Broadcom, it actually brings the rest of the market to that price/fair value of 1.0, indicating that the rest of the market, on average, is trading pretty close to fair value.

So, when I’m thinking about 2026, and we’ll highlight this in a bit, I expect a lot more volatility ahead, both to the upside as well to the downside, which is why we’re advocating to have more of a barbell approach to portfolios today. Again, we still want that upside to artificial intelligence. We specifically want to have it in those wide- and narrow-moat AI stocks that are undervalued, those at the technological leadership of their industries. We also want to balance that out with value stocks, and we’ll highlight in a couple more pages, where we see value stocks. But essentially, I think this is the way you’ll be able to play volatility this year. The market runs too hot to the upside, runs into the territory where it’s going to be overvalued, overextended. You can take profits in those AI stocks, which, of course, will be the ones leading to the upside, and then be able to reinvest those proceeds into value stocks. Because, of course, those will then lag to the upside. And conversely, when we have that downside volatility, those AI stocks probably get hit harder, but at the same point in time, value stocks will be able to hold up. Then you’d be able to take proceeds out of value stocks, put that into those AI stocks after they’ve sold off.

Not going to spend a lot of time on the historical returns, other than noting that in the fourth quarter, pretty decent return, 2.4%. We did see value stocks outperform over the course of the quarter. Growth stocks also holding in at 3.0%. Growth stocks down 1.6%. The value category is bolstered by healthcare. A couple of stocks we’ve highlighted on The Morning Filter, our weekly podcast. Johnson & Johnson JNJ, Thermo Scientific TMO, both being stocks we’ve highlighted as being undervalued. But I’d also note tech also had a very strong run, but it’s to the point where it’s overvalued at this point. We think now would be a good time to take some profits there. Core stocks, really all about Alphabet. I mean, it was partially offset by some AI exhaustion in stocks like Oracle ORCL, but really, most of that return really being driven by Alphabet’s outperformance. Growth stocks almost 80% of the loss there, really just driven by three stocks: Microsoft MSFT, Meta META, and Netflix NFLX. So, for the full year, 17.35% at the broad market, using the Morningstar US Market Index as our indicator here. And again, I think it’s interesting to note here value stocks, from an index perspective, did outperform.

What I have to note here is that the Morningstar US Market Index is an unconstrained index. It uses the full market capitalization of all of the stocks in the marketplace, but the style indexes, the value, core, and growth are what are known as constrained indexes. So when those indexes rebalance, I believe there’s like a certain limit as far as like what percentage an individual stock can have of those indexes. As those mega-cap stocks rise further and further into being extremely high percentages of the market overall, they’re actually rebalanced to lower percentages in those indexes. So, the growth index is up 14%. However, if you were to use really, truly that full market capitalization of growth stocks, I think it actually would have been up higher than that. This is one of those instances where I think they’re good indicators of returns. But in this case, because of the rebalancing, I think that actually ends up constraining some of the return in that growth category.

Just showing how our valuations have moved over the course of the year. Coming into the year at just a slight premium, not enough to scare us, enough to keep us at market weight. Market selling off, we thought the market had sold off too much. We actually moved to an overweight on the April 7 episode of our weekly podcast, The Morning Filter. We put out a special article and a special report that week as well, outlining our view on why it was time to overweight the market. Then, of course, the market has marched right back up, going back to market weight in the next couple of months, to the valuations that you can see in the style box today. Breaking it down in the fourth quarter, healthcare being by far the leader. That was a sector that we noted was, I think, the third-most undervalued sector last quarter. Really surprised me to the upside, just how much it outperformed. But a lot of it really was due to Eli Lilly LLY, with a couple of different catalysts that occurred there. And that was 39% of the sector return. Other than that, some pretty broad returns across the rest of the sector.

Communications, Alphabet, its increase was able to more than offset some of the pullbacks we saw in some of the other stocks like Meta, Netflix, and Roblox RBLX. Basic materials is all about gold and copper; Newmont Mining NEM and FCX [Freeport-McMoRan] were the ones that really bolstered the index there. Real estate, broad-based selloff. In fact, the breadth there was very bad, twice as many stocks declining as advancing. Similar pattern in utilities, twice as many negative performers as those that rose. And then consumer defensive, the losses here really generated by Costco COST and Procter & Gamble PG, two stocks that we’ve noted for most of the course of the year, Costco being a 1-star-rated stock, P&G a 2-star-rated stock, having fallen. I’ll just highlight at this point, P&G has fallen enough that it’s now into 3-star territory. For those of you looking for a good, strong consumer product company, this one might be worthwhile taking a look at here at that 3-star range.

2025, again all about artificial intelligence. Those sectors most closely linked to AI were the biggest performers for the year. Communications. I would just note that 82% of the return for that sector was driven just by Alphabet. Now that’s a stock we’ve been very constructive on for quite a while, but again, that stock really just raged over the course of the year. Technology, Nvidia 28% of the sector return, and if you were to add in Broadcom, Microsoft, Apple AAPL, and Micron to the sector, those were enough to get you two-thirds of the sector return. Utilities having become that second derivative play on artificial intelligence. AI chips require multiple times more electricity than traditional. Huge demand increases in electricity, so utilities just up across the board. And in industrials, large gains in the transportation companies, but really anything tied to the AI buildout boom really driving that sector higher.

Financials, everything that can go right has gone right in the financials for the banks. We saw earnings coming out, beating mostly on the top line, beating on the bottom line. Interestingly, though, as we’ll highlight in our valuations, a lot of those stocks were already priced for perfection or 2-star-rated stocks. We are seeing some of those sell off here in the short term following earnings. Consumer again, defensive again, it’s really due to Costco and P&G. And data centers, interestingly, in real estate, data centers are what caused real estate really to be hampered this year. Those were stocks that rallied too far to the upside, were 2-star-rated stocks coming into the year. That’s really what kept the real estate sector from performing well this year.

Taking a look at the top 10 contributors to 2025, they accounted for 53% of the market return overall. It was a higher percentage in the first half of the year. We did see some broadening out over the course of the second half of the year. And I would just say that, interestingly, now we do have a pretty differentiated view on the valuations for a number of these stocks. So, looking at some of these stocks that, at this point, really only one of them, Alphabet, is a 3-star-rated stock. That’s after increasing 55% in our fair value and the stock being up 65% over the course of the year. Nvidia, Broadcom, Microsoft, all 4-star-rated stocks. Meta also a 4-star-rated stock. But others that were the leaders for the year, Apple, JPMorgan JPM, Lilly, Micron, Palantir PLTR, all 2-star-rated stocks that we think are overvalued today. I expect to see bigger in 2026, based on our valuations for those stocks. Takeaway here for the detractors, really, no significant stock in and of itself as a significant detractor.

Just taking a look at these, I just know a lot of these stocks that were overvalued coming into the year have significantly underperformed. A lot of them have actually underperformed enough that they’re now starting to look very attractive, many of them in fair value territory, 3 stars, but even more now in that 4-star and some that 5-star territory, based on how much they’ve fallen over the course of the year. This graph, a number of times over the past couple years, just highlighting compared to the relative value of the overall market where value stocks were trading. With value stocks having traded up now, we’re now seeing that valuation getting pretty close to that broad market valuation. To some degree, at this point, we think that valuation or that relative valuation trade has played out, but we still see it in small-cap stocks. Small-cap stocks did outperform November, December last year. That’s taken a little bit of that discount out, but still comparatively to the broad market, small-cap stocks trading at very large discounts.

So, as far as volatility for the year ahead, these are really probably the biggest key themes and points that I’m watching to try and understand how there might be changes in the marketplace. Always a lot of noise in the marketplace. These are the areas that I would look more toward any change in signal in the marketplace. Thinking about AI stocks, they are at very high valuations. Those valuations, even based on our base case, still require even greater growth to support those valuations. But as we’ve seen, a lot of these stocks do still have further room to run, based on our base case, much less if AI were to play out like a lot of prognosticators think, there’s actually still a lot of upside in those stocks. So, for example, Nvidia, we’re looking for top line to get to $500 [billion], actually over $500 billion by 2030. Yet compared to what the CEO thinks AI spending is going to be in 2030, there’s probably even still greater upside if we’re actually going to meet what his expectations are. So, still some conservatism, even in our base case there. Of course, if any of these stocks disappoint to the downside, I think the market will end up selling first and asking questions later.

We, of course, have a new Fed chair taking the reins at the Federal Reserve coming in May. The next meeting after that will be June, so we’ll see what potential changes there may be in monetary policy. I expect by spring and summer of this year we’ll have the resumption of the trade and tariff negotiations. That’s actually been relatively quiet over the past couple of months. A lot of those have either been paused or suspended, but we’ll have a new, fresh look by the administration at the USMCA [United States-Mexico-Canada Agreement], I think coming up in the spring. And while we have a pause with a lot of the tariffs on some of the goods with China, and I think those probably expire, and I think it was November 2026. I suspect by the summer, we’ll be back into those negotiations and back into the headlines again. And I think that could certainly whipsaw the market.

Taking a look at economic growth, we’ve had unexpectedly very high economic growth for the past couple of quarters. But I’ll let Preston talk about his economic expectations for the next couple quarters and the next couple years. Certainly potential for hotter-than-expected inflation as compared to what market consensus is. I know Preston will address tariffs and the impact of tariffs over the next year. Political rhetoric in the United States, certainly very hot. We’ve got the midterm elections coming up, so that political rhetoric can become even hotter than where it is today. I think it’s also possible that we could see the current administration maybe try and push through much of their agenda over the next couple quarters while they still have control of Congress. So, we could see a lot of volatility in the political environment.

I’m also keeping a very close eye on the private credit markets. We are seeing weakening fundamentals there. I would just highlight DBRS Morningstar, that is our credit rating agency subsidiary, has private credit ratings outstanding on hundreds of these companies. They have a very good view into that marketplace. They’ve noted that in these middle-market and smaller companies, in that private credit market, generally, they’re seeing weakening fundamentals. They’re seeing EBITDA decrease, margins under pressure. That’s resulting in higher debt. That’s resulting in lower interest coverage. In fact, the number of these companies are now also requiring covenant waivers with their banks, also requiring the private equity sponsors to come in with new capital to be able to support those transactions. Again, at this point in time, there’s a lot of smoke there, not necessarily a lot of fire. But that is one of the largest asset classes in the marketplace today. I think private credit in and of itself is at least as large, if not larger than the public high-yield market and as big as the term-loan bank-debt market. So, any kind of issues in the private credit markets could certainly have systemic issues if we were to see credit there really fall off of a cliff.

China, always very difficult to really understand exactly what’s going on with the Chinese economy. My concern is that the economy there might actually be weaker than expected. Or we could see that their growth decelerating at an accelerating rate as the second-largest economy in the world. Certainly trying to keep an eye on and understand what all that might do to the US. And then, lastly, just watching Japanese government bond yields and watching FX [foreign exchange] for the Japanese yen. It’s called the widowmaker trade. It’s put a lot of people under long before even I started in the business. But if you look at Japanese government bonds, looking at their yields, they have steadily been moving higher and higher. Of course, as yields move up, that means those bond prices are decreasing. So, there are people who are taking either explicit or implicit losses on those bonds as yields go up. My concern there is if we started seeing those yields start to increase at an accelerating rate, you could start seeing some solvency issues with people that have a large percentage of their assets in JGBs. And similarly with the Japanese yen, that has been depreciating versus the US dollar very steadily for quite a while now. Again, if there’s an acceleration in the rate of that depreciation, that would cause me even greater concern with the Japanese yen carry trade.

Just quickly reviewing some of our sectors, we’ve shown this slide in the past. The big takeaway here is just showing how few 5-star-rated stocks there are. Historically, we had more than that. And again, less than 40% of the market on a percentage basis by number of companies that we cover trading even in that 4-star range. Using a heat map here, where we do see value again this technology sector at a very large discount. However, as we’ve noted, it’s really just two individual stocks, Broadcom and Nvidia, that are driving most of the undervaluation because they are such a large percentage of the overall market capitalization of the sector. Similarly in communications, Meta is really driving the undervaluation there. Whereas, like energy and real estate, we see broad valuation across most of those sectors.

Taking a look at some of our calls here by sector, real estate is still the most undervalued sector. Now, personally, I would still steer clear of urban office space. I still don’t like the risk/reward dynamics with valuations there. But a lot of the more defensive sectors within real estate, I see a lot of value. Two stocks, AMT [American Tower] and CCI [Crown Castle], wireless tower providers, those are stocks that account for a lot of the undervaluation within that sector. Realty Income O, another stock that we’ve been constructive on for quite a while, I think are good ones for investors to take a look at. Technology, a lot of that valuation is going to be in Nvidia, Microsoft, and Broadcom. Energy, taking a look at that sector, we think that the market is being overly pessimistic, even utilizing the two-year forward curve for where oil prices are now. And our long-term view for oil over the midcycle, we think that there’s a lot of value, specifically within the US oil producers. We’ve also been very constructive on a number of the services companies like SLB, the old Schlumberger, and Halliburton HAL. Those stocks have had a pretty strong rally here in the past couple weeks since we saw the change in government in Venezuela. I think those probably still have a pretty good tailwinds behind them.

And then, lastly, communications. Actually, Google has run up even further this year. So, it’s really all about Meta within the communications sector. A couple of other stocks, like Verizon VZ, that we still think are undervalued. And then those overvalued sectors, consumer defensive, it’s all about Walmart WMT and Costco. Once you get away from those 1-star-rated stocks, a lot of value in the CPG, the consumer product companies, a lot of value in the food companies. Value stocks trading at relatively low multiples with high dividend yields, a lot to like there from a defensive point of view. Financials, this is probably going to be a little bit less overvalued, seeing some of the US mega banks sell off the past couple of days. But again, the market, we think, is just valuing those stocks too high. Fundamentals look great, but when you think about them, how they normalize over a full economic cycle, they just run too far, too fast. And then industrials, a couple of stocks here to highlight as well.

A couple of new best picks here, bolded, Albemarle ALB, that’s our pick for lithium. I’m not going to spend a lot of time there. I would just note that if you look at lithium prices, they had skyrocketed in 2021, 2022. Stocks like Albemarle were 2-star-rated stocks we thought had run way too far to the upside at this point. Lithium prices have come crashing down in 2023 and 2024. Looks like they’re bottoming out here in August 2025. I think now might be a good time to take another look at the lithium plays, Albemarle being our favorite there. One of the low-cost providers, which is how it earns its narrow economic moat.

Another couple of stocks to highlight here, Omnicom OMC. This is one we just talked about on The Morning Filter recently. Advertising company. This one’s gotten lumped in with a lot of the more software-oriented companies. That people are concerned that how artificial intelligence may impact those underlying businesses over time. We think that’s being overextrapolated too pessimistically at this point in time. In fact, just the way AI plays out and how you’re going to need people that can help companies advertise across digital platforms, traditional platforms, and incorporate artificial intelligence into advertising and marketing. We think you’ll need the expertise of some of these large advertising companies, like Omnicom. CarMax KMX, also a new one. I’d note here it shows the consumer cyclical under the sector. That’s because of the SIC [Standard Industrial Classification] code that it’s under, but it is covered by our industrials team. And, of course, Broadcom, I’ve already highlighted a number of times today.

Among your defensive new picks here, I’m going to highlight a Mondelez MDLZ. Now this, I think, is a great pick for people who are looking for emerging-market exposure, but don’t want that same kind of emerging-market risk in their portfolio. So, valuations in the US, yes, admittedly very high. Of course, a lot of those valuations are going to be in individual stocks as opposed to the broad market. But a lot of people are looking for that emerging-market exposure. In this case, I think about 40% of Mondelez’s revenue does come from emerging markets, the other 60% from the developed markets. I think that’s about twice as much emerging market exposure as you’re going to see in some of the other US domestic food companies. I think that’s a good, interesting one. 25% discount, wide economic moat, Low Uncertainty, high dividend yield. I think that’s an interesting one to take a look at.

And then Alliant Energy LNT will be the one that I’m going to highlight here as the new pick among utilities that we think not only is undervalued, but also probably has some of the better exposure now towards the increase in electricity demand from AI. Valuation by economic moat. Moat stocks are very undervalued compared to the rest of the market. But again, if you were to strip Nvidia, Microsoft, Broadcom, and Meta out of that, takes the wide-moat stocks, to a 1% premium. So, kind of in line with the rest of the market, but I think it does highlight a number of different swap opportunities and how you can be able to put that in your portfolio. For example, if you look at large no-moat companies, companies like Micron and Intel INTC, those stocks we think have just, especially in the past couple weeks here, have run up way too far. These are companies that we no longer think. Well, Micron, we’ve never had an economic moat there, until we strip that company of their narrow moat, I believe, over the course of last year. And again, that’s a company that we think has fallen behind the technology curve. So you can swap out of those companies at profits and be able to reinvest that into wide-moat stocks like Microsoft or Pepsi PEP. I do this every quarter, so I’ll let people take a look at our slide deck if they have an interest here. But again, looking for undervalued large-cap stocks, those with a wide economic moat and a Low or Medium Uncertainty, rank ordered by price to fair value. Similar here for mid-cap stocks with wide economic moats, Low and Medium Uncertainty. And then small-cap stocks. And again, here I do add in narrow-moat stocks, just because there aren’t very many small-cap companies that we do rate with a wide economic moat.

So, with that, I’m going to give my voice a break, take a quick drink of water, and I’m going to pass it over to Preston for his US economic outlook.

Preston Caldwell: Thank you, Dave. Good morning, everyone. Back in January of last year, we were expecting GDP growth of 2% in 2025. And it looks like that’s right about where we ended up. The data will be reported next month. But compared to where our expectations were in April of last year, immediately after the tariff announcement, that the economy has done much better. At that point, we were expecting GDP growth of just 1.2% in 2025 and 0.8% in 2026. And consensus was similar. Why did the economy outperform those post-tariff announcement expectations? Well, of course, we know the tariffs were pared back a good deal. But also for the tariffs that did remain in place, the impact was much less than feared. And then, secondly, we know, of course, that AI was a major factor in propping up the economy this last year. And that continues into 2026.

Now, we do expect a bit of lingering tariff impact ahead, depending on exactly what transpires with the Supreme Court decision and all that to weigh on GDP growth in 2026, along with some other factors. But we do expect a growth acceleration to start to filter in sequentially into the quarterly data in the latter half of 2027, and really, as you see in the annual average figures playing out in ’28 and ’29, a growth acceleration driven by further monetary policy loosening. And on inflation, likewise, the tariff impact was lower than feared. Although without inflation, I’d estimate that inflation, and sorry, without tariffs, I’d estimate that inflation would have been around 20 or 30 basis points lower in 2025. So, based on the easing and housing inflation in 2025, that would have driven this continued downward march in the overall inflation rate. But that was offset by a small uptick in goods price inflation, which was likely mostly driven by tariffs. But we do expect inflation to eventually get back about to the Fed’s 2% target as the tariff impact fully fades.

On interest rates, we’re expecting an additional 125 basis points in federal-funds rate cuts. And that should be sufficient in order to also drive longer-term yields down, which really hasn’t been the case so far during this phase of monetary policy loosening. Despite the federal-funds rate having come down by 175 basis points, really, all that’s amounted to is an un-inversion of the yield curve. So, longer-term rates, the 10-year Treasury is currently at about 4.15%, which is about where it averaged 4.3% in 2025 and 4.2% in 2024. And a little bit more relief on mortgage rates, currently sitting at 6.1%. But still, I think much more reduction in terms of longer-term rates is needed in order to sustain healthy economic growth, especially with the housing market, where homebuyers have been placated for several years now with this story that they can refinance at lower rates. And at some point, that will have to actually transpire. And so I think the Fed will deliver the rate reductions necessary needed to accommodate that. And push the 10-year Treasury yield down to 3.25% by 2028, and the 30-year mortgage rate down to 5%.

So, on tariffs, the first thing that I want to do is stated average tariff rate and the actual average tariff rate. The stated tariff rate is derived by just looking at all the announcements for the various tariff rate increases and applying that, weighting that using 2024 import volumes. And then the actual tariff rate is just looking at total tariff revenue divided by total imports. And so one factor that has heavily mitigated the tariff impact is that the actual increase in tariffs has been much smaller than we would have expected based on what was announced. And we can account for some of this based off of substitution to lower tariff jurisdictions and products, but a lot of this really is unexplained. It’s just not clear if the exemptions are being applied more leniently in practice than the executive orders would suggest. But, in any case, you can see there’s a huge gap between the two. So, the actual average tariff rate was only on average about 9% in 2025, versus the stated tariff rate averaging 14% for the year. And we currently stand at about 15% for the stated average tariff rate.

Now, in the immediate aftermath of the Supreme Court decision, that stated average tariff rate would fall to about 7% if the Supreme Court strikes down the IEEPA [International Emergency Economic Powers Act] tariffs. We assume about a 75% probability the Supreme Court will do that, will strike down the IEEPA tariffs. However, we’re expecting that the Trump administration comes in with other statutory authority, of which there is plenty to cite, in order to replace much of the tariffs that are struck down. So, after that decision comes, we don’t know when the next date that the decision could come is, but we’ll be looking over that following week to see what comes from the Trump administration, if they’re already waiting in the wings with replacement tariffs or not. So, the court decision itself won’t affect our forecast so much as the Trump administration’s reaction to it. We’ll have to wait and see on that. But as it stands, we are expecting a gradual reduction in tariffs in coming years.

We do have midterm elections this year, which very likely could at least switch control of the House. And then, of course, a new presidential election in 2028. And not to mention, I think if the tariffs are kept in place, we will see further increase in consumer prices. And the effects of that are likely to provoke some backlash, which would likely induce further reduction in the tariff rates. And as it stands, just looking at the bottom chart, we’ve seen very little pass through in the consumer prices so far. Core goods prices are only up about 1.0%, 1.5% since the start of the tariffs. Import prices, inclusive of tariffs, are up around 10%. So, we know it’s not the case, the data is clear that foreigners are not paying for the tariffs, but neither are US consumers. So, that leaves the business sector as the only one who can be paying for these tariffs, logically. And that’s what the data shows. I don’t think it’s likely that businesses are going to eat the tariffs indefinitely.

Why are businesses doing this? I would say one factor is that businesses have been running down pre-tariff inventories, which has allowed them to delay recognition of tariff costs in accounting terms. And I think increasingly, in the latter half of last year, businesses have been expecting the Supreme Court to bail them out by striking down the IEEPA tariffs. But of course, even if those tariffs are struck down, then if the administration comes back with new tariffs that just replace the old ones, then at some point, I do think businesses are going to recognize their pricing has to recalibrate based on higher costs. And once it starts flowing into the earnings, actually, after the pre-tariff inventory is run down, the shareholders will demand it. So, all that’s to say that there could be further tariff impact ahead, depending on what happens with the Supreme Court decision and the likelihood that we could get further pass-through into consumer prices.

As it stands, the economy has been very minimally impacted by the tariffs in terms of the rate of GDP growth. We did see GDP growth decline to 2.1% in 2025, looking at the first three quarters of data, down from 2.8% in 2024. There’s a lot of noise in the data, so if you just look at the sequential growth rate in GDP, it was very strong in the second and third quarters of the year, but that’s distorted by net exports and inventories. Those are very volatile components in GDP, so you tend to want to strip them out to look at the underlying trend, which is, by stripping them out, we get final domestic demand, which is just total consumption, private consumption, private investment, and government expenditure.

And you see on the bottom chart that final domestic demand there was some recovery in the second and third quarters last year, but still a kind of gradual downtrend in growth compared to 2024. That was driven by a government expenditure, both federal and state and local, as well as also a slowdown in private fixed investment, as you can see. Which might sound surprising, given the eye-popping AI investment figures that we’ve all seen. But every other part of private fixed investment was much weaker, significantly weaker in 2025 compared to the last several years. And that offset the increase in AI-related expenditure. Personal consumption has gradually drifted down if you look a little bit more fine-grained at the figures. In the fourth quarter of 2024, consumption was up 3.4% year over year. And so that has decelerated to around 2.4% as of the third quarter of 2025. So, there is something of a downtrend that’s driven mostly by goods, as opposed to services, where I think goods are a little more discretionary. And maybe consumers have gotten impatient with goods prices, which still haven’t fully unwound their pandemic-era increase, spike in prices that we saw.

Now, one factor I think that also is going to continue to weigh on consumption growth is the low personal savings rate or household savings rate that’s prevailing. That averaged 4.8% in the third quarter of 2025. And so that still lags by 2.5 percentage points, the 7.3% average savings rate in 2019. Part of this is explained by household wealth, which has soared by 55% of GDP since 2019. But that doesn’t explain all of it. And then, of course, if we do get any kind of unwind in asset prices, that could very quickly, that the wealth effect could weigh on consumption, even insofar as it’s been propping it over up over the past two years. So, I do think overall, households are likely to move in a more cautious direction and seek to boost that savings rate, which will entail a slightly slowing consumption growth. And so you can see our forecast for consumption here on the top chart, and then on the bottom chart, we also forecast investment growth to slow slightly in 2026. I think AI-related spend will still be very fast but not growing quite as fast as in 2025. Right now, consensus is estimating 30% growth for the hyperscalers’ capex in 2026, compared to 70% growth in 2025. So, still astronomical, but not quite as high as 2025. I think we will see more tariff impact in 2026 on investment, on businesses’ investment, as well as a knock-on impact from slowing consumption growth. But then, in 2027 and following years, we should see investments start to rebound as monetary policy easing kicks in.

The labor market has continued to slow in terms of job growth. Our estimate of the benchmark revision, which will be incorporated in the data next month, that’s an annual occurrence, we estimate that nonfarm payroll employment was probably flat in year-over-year terms as of the December data. So, zero growth over an entire year. That’s a pretty remarkable slowdown. A normal rate of growth would be 1.0% to 1.5% for nonfarm payroll employment. However, we know that both labor supply and labor demand is contracting. We’re not really, and the Fed as well, not concerned about such a slowdown if it represents a commensurate fall in both labor supply and labor demand in tandem. But I do think the fall in labor demand is probably exceeding the fall in labor supply. We do see the unemployment rate having increased to 4.5% compared to 4.1% at the beginning of this year. And altogether, we’re up by about a percentage point compared to the trough in 2023. And so, I think there is a gradually increasing amount of slack in the labor market. And we also see that reflected in wage growth, which has also been fairly modest recently, especially compared to inflation still being elevated.

So, as I mentioned, in 2025, we did see an uptick in goods inflation, heavily tariff-driven, but that was offset by a deceleration in housing inflation, based on the data we have so far. And in 2026, we expect that to continue further. More goods inflation, core goods prices overall increasing about 2%, but housing inflation decelerating further. And that decline in housing inflation is something that’s been very much telegraphed in advance by the leading-edge data we have for market rents. And then in following years, you can see as that tariff inflation goes back down to more normal levels, then the overall rate of inflation should converge back about to the Fed’s 2% target.

In terms of our expectations for the federal-funds rate, we expect, as I mentioned, another 125 basis points in rate cuts, two this year, three next, 2.25% to 2.50%, which is 75 basis points below where the market is at. So, we expect a terminal federal-funds rate, which is much closer to where things were before the pandemic. We averaged a federal-funds rate of 1.7% over 2017 to 2019. And this is based off of our view of the natural rate of interest. That is, the forces that have pushed the natural rate of interest down over the last four decades, really, like aging demographics, still remain in place as much as ever. And so, we see the rise in interest rates postpandemic as being more of a transient phenomenon.

With that, I’ll pass it back to Dave. Thank you.

David Sekera: All right. Thank you, Preston. Let me apologize to everyone. I spoke way too much at the beginning, so we’re running out of time, but I want to get to as many questions as we can. I’m going to just flip through some of these slides. I believe the slides are available to everybody in the attachments section, so you can pull these down and review at your leisure. Again, just taking a look at how large these have become as a percent of the market, how these have performed, the undervalued mega-cap performance from last quarter, overvalued mega-cap, and so forth. But again, I want to run through these. The only thing I really want to focus on before we get to the questions is going to be the credit markets. Interest rate forecast using Preston’s forecast, I still think you’re best off in long-duration bonds, kind of locking in those 4%-plus bond yields before they break through the four handle into that three area. But taking a look at corporate credit spreads and how tight they are, and I know this past quarter, the Morningstar US Corporate Bond Index, which is our proxy for the investment-grade index, even hit new all-time tight levels. And taking a look at high yield, they’re tighter by 15 to 275.

I have a lot of concerns about the private credit market. And taking a look at where spreads are today, all the way back to 2000, looking at both investment grade and high yield, rarely, ever have any of these spreads ever been tighter. I think we’re in the part of the cycle where you’re picking up pennies in front of the steamroller. It’s great money all the way up until the point that you get run over. Personally, I would prefer just sticking with Treasuries and maybe some of the government-sponsored entities, some of the mortgage-backed bonds, as opposed to venturing into the corporate bond market. If you want to pick up some of that excess spread that you get in the corporate bond market today, I would just keep a really itchy finger on the trigger. As soon as you see any kind of risk, any kind of market downturns, you might want to go ahead and take some of the money off the table and move it back into more of that Treasury portion of your portfolio. Again, just my own opinion. You can see at the beginning of this year when the credit markets crack, especially at the tight spreads that we’re at today, they’re gonna crack, and they’re gonna crack fast. In this case, they came roaring back with the equity markets thereafter, but much more concerned if we did have a slowing economy, slower than expected. If you were to start seeing downgrades pick up, defaults pick up, I would look for high yield to easily get to 500 over, which even 500 over isn’t all that high compared to historically, where we’ve seen it over time.