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Wall Street is optimistic about the first six months of 2026.
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With the S&P 500 rising about 16% this year as of mid-December, 2025 has been good for investors. Though Wall Street isn’t expecting a repeat, it’s optimistic about the first six months of 2026, forecasting an 11% increase in the S&P 500 for the year.
Interest rates are expected to drop because the labor market is shaky even as inflation remains above the Federal Reserve’s 2% target. Corporate earnings are expected to push up stocks. Capital flowing into artificial intelligence will drive growth, particularly among builders of AI data centers and the energy providers that keep them running, as agentic AI enters the mainstream.
The Macroeconomic Landscape: Inflation And Interest Rates
The Federal Reserve is in an easing cycle, having cut rates in recent months to support a cooling labor market. This is despite an inflation rate topping the Fed’s 2% target and a lack of timely government data on inflation and the state of the economy.
While interest rates are expected to decline, some analysts forecast a drop in the rate of inflation, despite tariffs on imported goods that providers are generally passing on to consumers in the form of higher prices.
Current Federal Reserve Stance
The Fed shifted its focus from fighting inflation to supporting maximum employment when, on Dec. 10, it lowered the federal funds rate target to between 3.5% and 3.75%.
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The cut was expected, with investors giving it an 87% probability, according to Morningstar. The reason for the cut was “insurance” to protect the labor market. It is likely the combination of higher costs from tariffs and the availability of AI to get more work done with fewer people — the biggest driver of the weak labor market, not high interest rates.
There were two big surprises:
- Three officials on the Fed board dissented — two opposed the cut and one was looking for a deeper cut.
- The Fed said it was likely done with cuts for now, which was a bit of a surprise, noted The Wall Street Journal. But Fed Chair Jerome Powell’s term ends in May, and his successor — who is likely to be appointed because he will cut rates regardless of inflation — could make this pause a short one.
Interest Rate Outlook For Early2026 (First and Second Quarters)
Major financial institutions envision a more aggressive easing in the first half of 2026 to counter economic headwinds. Morgan Stanley projects a rate cut as early as January 2026, while Goldman Sachs expects the Fed to pause in January before delivering a cut in March. Goldman Sachs and other firms forecast additional reductions in June, pushing the rate closer to a range of 3.0% and 3.25% by midyear.
Inflation Trends In 2026
Inflation remains a full percentage point above the Fed’s 2% target. The consumer price and personal consumption expenditures indexes are around 3%, reported The New York Times, which also reported that the most recent report for September 2025 reflects delays in reporting data attributed to the 2025 government shutdown in November.
Inflation is expected to moderate slowly in 2026. Trading Economics models and analyst surveys predict inflation will trend toward 2.6% in 2026, staying above the Fed’s target because of the effects of tariffs and housing costs.
S&P 500 And Nasdaq Consensus Targets
Major financial institutions have released their outlooks for 2026, according to MarketWatch. While almost all firms provide specific price targets for the S&P 500, index targets for the Nasdaq are rare. Instead, firms express their tech-heavy Nasdaq views through sector ratings such as “Overweight Technology” and “Magnificent 7” earnings forecasts.
Nasdaq And Technology Sector Forecasts
While these firms do not generally provide price targets for the Nasdaq Composite, here are some of their comments on the technology and AI sectors.
- “Magnificent 7” earnings: J.P. Morgan projects that the “Magnificent 7” (the primary drivers of the Nasdaq) will achieve roughly 20% earnings per share growth in 2026, a much faster rate than the S&P 500’s 13% to 15% EPS growth next year.
- AI spending boom: Capital Economics and other firms note hyperscale companies are expected to spend more than $500 billion on AI-related capital expenditures, which could propel shares of semiconductor and software companies.
- Sector ratings: Citi and Morgan Stanley maintain a preference for “Large Cap Growth” and “Technology,” signaling their optimism about a rise in the Nasdaq relative to other indexes.
Key Themes Driving The Market In 2026
AI, geopolitical forces and corporate earnings growth are likely to drive markets in 2026. If AI begins to demonstrate a tangible return on investment for companies in 2026, investors could propel shares of hyperscalers, data center builders and suppliers, and providers of energy that keep them running.
As always, markets will move in response to quarterly earnings reports. Capital will flow into the companies that grow faster than the Wall Street consensus and raise guidance to above-expectations levels. Conversely, companies that fall short of consensus growth targets and forecasts will see their stock prices plunge.
The Artificial Intelligence Evolution
AI could change in 2026. Most notably, agentic AI — systems that, say, enable people to search for a vacation destination, pick the best flights and hotels, and pay for them — could unlock hoped-for productivity gains, spurring 75% of companies to invest, noted Deloitte. Forrester highlighted how companies will keep a sharp eye on potential returns.
Meanwhile, investment in data centers by hyperscalers is likely to boost economic growth among all the builders and suppliers of this construction. Amazon, Microsoft, Google and Meta are projected to increase capital expenditure 36% to about $602 billion in 2026, according to CreditSights.
Such spending could be a powerful force offsetting the economic headwinds of consumers squeezed by prices growing more rapidly than their income growth, reported Vanguard and Barclays.
AI data centers’ significant power demands will motivate leaders to invest in energy security and grid modernization, wrote Goldman Sachs.
Geopolitical Factors
The trend of countries putting their economic interests ahead of global ones will keep inflation high due to tariff wars, noted Natixis, reshape supply chains and redirect capital flows toward sectors aligned with national interests.
In 2026, such global fragmentation will drive more countries to put their economic security above efficiency, J.P. Morgan and Allianz reported. Investors will need to structure their portfolios to hedge against persistent trade tensions, particularly between the U.S. and China.
Such tensions will accelerate the locating of operations in countries friendly to the largest nations such as the U.S. and China, Prologis reported. Moreover, countries will implement industrial policies aiming to mitigate risks in critical technology and defense industries, according to Morgan Stanley.
Capital will increasingly flow toward defense, cybersecurity and energy infrastructure sectors, as nations prioritize sovereignty over cost optimization.
Corporate Earnings Growth
Analysts envision a surge in profitability driven by AI-led productivity gains and a resilient economy.
Earnings could hit a record in 2026. FactSet data calculated record-high S&P 500 earnings in 2026 of $309. Natixis envisioned a shift from AI hype to delivering tangible productivity improvements and margin expansion.
Nontechnology sectors are also expected to grow in 2026. Communication services and industrials will expand, reported Fidelity, while Bank of America envisioned a “security supercycle,” driven by data center energy needs, boosting defense, power and utilities earnings.
Sectors To Watch In The First Half Of 2026
In the first half of 2026, investors should keep an eye on a range of industries, including semiconductors, data center liquid cooling, advertising, healthcare and biotechnology. Analysts point to specific areas of growth within these industries.
Technology And Communication Services
Semiconductors and the power they consume will create growth. In 2026, the global semiconductor industry is expected to increase 26% to $1 trillion, fueled by logic and memory chips essential for AI, according to the Semiconductor Industry Association. As the power consumption of AI chips rises to more than 1,000 watts, deployment of liquid cooling is expected to spread, according to Data Center Dynamics. This could benefit Vertiv, a leading supplier I wrote about July.
Communications services, such as advertising and telecommunications, will surge in 2026. The Winter Olympics in February will contribute to a 5.1% increase in global advertising spending to more than $1 trillion, noted Dentsu, boosting broadcasting and digital platform revenues. Meanwhile, telecom service providers will scale significantly as they adopt AI agents to handle customer service.
Healthcare And Biotechnology
AI adoption will boost growth while patent expirations may spur consolidation in the health care and biotechnology sectors.
AI is expected to streamline health care operations in 2026. An estimated 30% of industry leaders are using agentic AI for patient scheduling and data analysis to make operations more efficient, according to Deloitte.
Moreover, the largest pharmaceutical companies are likely to face a drop in revenue as patents expire. Some $300 billion in lost revenue will drive them to acquire biotechnology companies with expertise in oncology and immunology, noted Janus Henderson.
Potential Risks And Headwinds In 2026
While the consensus outlook for the first half of 2026 is cautiously optimistic, investors should monitor risks such as economic stagnation, persistent inflation and stretched valuations.
Recession risks could threaten earnings growth and send stocks down. J.P. Morgan Global Research assigned a 35% probability to a U.S. and global recession in 2026, citing potential “cyclical weakening” in the labor market as a primary trigger.
Indeed, with consumer spending accounting for about 70% of gross domestic product growth, there is a 30% chance of recession should businesses fail to hire new labor market entrants. If the unemployment rate rises accordingly, the lack of spending capacity could drive economic contraction, noted MetLife Investment Management.
Such a rise in unemployment could be coupled with inflation — dubbed “stagflation light” by Royal Bank of Canada. Charles Schwab predicted inflation of 3%, possibly growing as tariffs boost retail prices by nearly five percentage points. Such a rise in inflation could force the Fed to stop cutting interest rates.
Valuations are high and could plunge should the top 10 stocks in the S&P 500 — AI growth beneficiaries that account for 40% of market capitalization — fail to generate expected earnings growth. Goldman Sachs CEO David Solomon has warned of a potential 10% to 20% decline in equity markets over the next one or two years as investors reassess high multiples, according to CNBC.
And while AI infrastructure spending is booming, the “path to realized earnings remains unclear,” meaning any disappointment in adoption or monetization could trigger a sharp repricing of tech megacaps that drags down the broader index, noted Desjardins.
Key Takeaways
2026 looks to be a good year in the markets, though not as good as 2025. Investors should keep a close eye on whether companies driving the AI boom can continue to beat Wall Street expectations and raise guidance. That could depend on whether companies buying their wares are able to earn a tangible return on their investments.