Rotating into value stocks could become more popular in the new year. Value stocks (companies undervalued by the market) underperformed throughout 2025, but recovered by the end of the year. As of Tuesday, the iShares Russell 1000 Value ETF (IWD) had outperformed this month and this quarter, rising 0.8% and 3.9%, respectively. By comparison, the iShares Russell 1000 Growth ETF (IWF) rose 0.6% and 2.3% over the same period. Value may continue to perform well next year. The S&P 500 is expected to post another double-digit gain in 2026, but the gains are expected to be more difficult. Investors worried that a bid for artificial intelligence stocks from late 2022 onwards could end up being a bubble burst are looking for cheaper assets with less risk. “A lot has changed in the last few weeks,” said Justin Bergner, portfolio manager at Gabelli Funds. “And as far as next year goes, I think that will continue to drive value rotation.” An extended bull market is considered healthy for the market. Rather than a rally led by a handful of hyperscalers, a broad range of non-tech stocks drove the market in December. The S&P 500 and financial stocks hit record highs on Tuesday, and small-cap stocks hit similar records at the start of the month. The equally weighted S&P 500 outperforms the market cap weighted index. The broader stock market doesn’t have the same panache as the market’s biggest artificial intelligence, but the outperformance of these sectors in December suggests the bull market is sustainable for now. Value’s recent leadership has some investors predicting a “value rebound.” The conditions for a comeback are definitely in place. If the Fed lowers interest rates in the first half of 2026 and AI improves worker productivity, combined with tax cuts from the Trump administration’s One, Big, Beautiful Bill Act, it could boost profits for many companies not in the AI rally. “Raising the productivity growth rate limit means the economy can (grow) at 2.5% in real terms without inflation becoming an issue, which is a tailwind for fundamental factors (GARP, value, earnings growth, earnings momentum) and procyclical stocks,” Dennis Debouchere, chief market strategist at 22V Research, said in a note this month. “That is our central theme in 2025 and will continue to be,” he said, adding that banks and consumer equities are two ways to address this theme. Indeed, investors will need to figure out which undervalued stocks stand to benefit the most next year. Small-cap stocks, for example, are undervalued, trading at a 27% discount to large-cap stocks, according to Leuthold Group. However, just because the valuation is low does not necessarily mean that outperformance can be expected. “We don’t use valuation as a timing tool, but rather as the risk profile of an index,” said Phil Segner, co-portfolio manager of the Leuthold Grizzly Short Fund. “Well, the average stock in our world right now is much less risky. But that doesn’t guarantee that they’ll outperform this year or next.” In other words, whether a particular stock does well depends on what happens in the market as a whole.
