Like a scripted first drive in a playoff game by a good football coach, Wall Street’s start to 2026 went exactly as planned, with a balanced attack and a rhythmic attack that gave the Bulls an early lead. Not only is the S&P 500 up 1.7%, it’s widened as almost every play call demands, with the like-weighted S&P leading by almost twice. Relentless consensus calls for a reacceleration of the real economy this year, driven by an administration hell-bent on tax stimulus and “boosting the economy,” are quickly being reflected in market leadership. Strong performance in banks, transportation stocks, hotels and small-cap stocks has helped offset some of the cooling in tech stocks that have been the mainstay of the S&P’s 80% three-year rally. “Everyone is expecting a good economy,” said Michael Hartnett, global strategist at Bank of America. And while betting on a biased consensus can be uncomfortable, and Hartnett’s own indicators of investor sentiment warn against being overly bullish, he currently believes the weight of evidence still favors a reacceleration thesis: the Fed cuts rates rather than raises them, the Fed resumes QE purchases of short-term Treasuries, and President Trump begins QE purchases of MBS. (The president’s order last week to have government-backed mortgage companies buy $200 billion in mortgage loans to help lower home borrowing rates isn’t strictly quantitative easing, but it does shore up demand for less price-sensitive loans in an unstressed market, and it signals that the administration intends to stimulate demand as much as possible.) This crowd-pleasing pattern of procyclical expansion has been in the works in some form since around Halloween. The Magnificent 7 and a miscellany of low-grade speculative stocks hit new highs on a relative basis, while the composite index turned sideways, with some catch-up trading in non-tech cyclicals and value plays. .SPX 6M Mountain S&P 500, 6 Months In fact, the S&P 500 was unable to beat its Oct. 29 intraday high by more than a few points, but by Friday the large-cap-led Nasdaq 100 was at the helm, rising 1%, nearly double the gain of the similarly weighted S&P 500 that day. This morning’s soft jobs report and the absence of a Supreme Court ruling on the legality of President Trump’s tariffs appears to have prompted a modest easing of the “Run It Hot” rotation, reminding those eager for a benign-looking market expansion that they may have to accept more subdued index gains. Overconfident? So far, there’s not much to argue about with markets moving back and forth across sectors and themes. The index’s new all-time high is more of a bullish sign than a warning. Earnings forecasts are similarly close to their all-time high for 2026, but they have edged lower in recent days. The financial situation is weak. Additionally, although the Fed is expected to hold steady in January, underlying expectations for consumer recovery and a continued boom in business investment mean that the market won’t need much support from the Fed. When the price movement is clear and the fundamental story is solid, the main danger is overconfidence and overvaluation that can result from overestimation of positive macro trends. There was a “slightly manic atmosphere at the beginning of the year,” said Chris Verrone, technical macro strategist at Strategas Research. I see it in the sense of urgency with which investors are implementing the agreed-upon circular trade, and in the rapid flow of money into data storage stocks to chase the structural memory chip shortage. Professional investors start the year with a new “risk budget” and want to spend it within six business days. Strategas’ composite Investor Sentiment rating of eight market-based and research factors is in the median 80th percentile for the company’s history. Inputs such as large ETF inflows, high options speculation, and low demand for volatility protection are driving this number. Separately, leveraged funds’ long positions in Russell 2000 Index futures are currently at the 94th percentile of the past two years of measurements. This is by no means a complete sell signal, but rather a potential new issue to be aware of, suggesting that the market has a thin underlying psychological and positioning cushion to absorb shocks. The gauge was in a similar position a year ago, and while it continued to rise, it set the stage for the deep-seeking shock for AI stocks and February’s momentum reversal that stormed the Nasdaq. A relevant question for cyclical bulls is how much of the expected growth acceleration in the recent rally has been paid for up front. It’s hard to argue with the standard Wall Street view that rising valuations do little to thwart a bull market when earnings are expanding and the Fed is leaning more toward accommodative policy than tightening. I also often hear that the market is undervalued, except for the biggest growth stocks. Yes and no. When looking at the equal-weighted S&P 500’s forward price-to-earnings ratio, the median valuation of large-cap stocks is significantly lower than the overall index of large stocks. However, while the equal-weighted P/E ratio is just over 17 times, it has rarely been much higher outside of the COVID-19 pandemic, which has caused earnings to plummet. Similarly, a small sample of well-valued, high-quality cyclical stocks, such as American Express, Williams-Sonoma, and Packer, are already trading at or near their peak multiples relative to their own history. Admittedly, this may be an old-fashioned, spoiled view of the market. Perhaps a genuine economic boom could cause profit forecasts to continue. Stocks may have been too cheap in some ways in past cycles. Perhaps there are real technological changes and productivity breakthroughs afoot that will make such static P/E-based arguments seem strangely misguided. The dawn of such a bright new era is one of the things that could redeem American companies’ decisions to give up hundreds of billions of dollars in free cash flow to build a promising AI future. The competition for capital spending among the world’s largest and most profitable companies has depleted free cash flow, which has been the primary reason companies have commanded premium valuations over the past 15 years. Currently, the S&P 500 Index’s future free cash flow yield is trading at 3.5%. In other words, it’s 28.5 times next year’s free cash flow. Three years ago, this FCF multiple was 20x. On a related note, the spending binge would dampen overall stock buyback activity, which has already been carried out at a lower intensity in recent years, with the S&P 500’s total annual stock buybacks last year representing just 1.8% of the index’s market capitalization. Again, these are simply widespread atmospheric conditions that could develop into troublesome weather in the future and are not imminent storm warnings. Given that the S&P 500 suffered a mini-crash nine months ago and the momentum from the bottom continues to confirm the credibility of this uptrend, I wouldn’t say the market is “in time” for a particularly serious gut check. On the bright side, the hyper-enthusiastic talk about the AI bubble has died down in recent months, as the Magnificent 7 stocks have diverged and some have underperformed. Is the fact that Nvidia stock can’t pull itself out, and that Bitcoin is dead money starting two weeks after the 2024 election, a dangerous aspect for risk appetite and broad tape? Or does the S&P 500’s ability to hit new all-time highs despite such blemishes demonstrate durable strength?
