With the holiday decorations now back in their storage bins and investment professionals having returned to their desks, it appears that the serious work in the markets for the new year has officially begun. And so far at least, investors seem to have an optimistic outlook for the stock market in 2026 as the S&P 500 sports a gain of +1.76% so far. Not bad. Not bad at all.

Looking at the year ahead, most every Wall Street bank is looking for another strong year in the stock market. Sure, the leadership might look different this year, we're told. But the bottom line is the consensus view on the street is that stock prices should see healthy gains in 2026.

How is this possible with all the fretting about AI Bubbles, geopolitical events, inflation, and extreme valuations, you ask? Since this is a question I have grappled with myself recently, I thought this might be a good time to review the big-picture fundamental drivers of the stock market.

If I've learned anything in my 40+ years of managing other people's money for a living, it is that although near-term movements in the stock market are nearly impossible to predict, staying in tune with the state of the macro backdrop can go a long way in helping one get the really important moves in the market "mostly right, most of the time." In short, staying on the correct side of the prevailing primary cycle is my primary goal in this job.

So, without further ado, let's take a quick look at those macro drivers, namely the state of the economy, corporate earnings, inflation, the Fed/interest rates, and of course, valuations.

Since there is a LOT of ground to cover here and I doubt very many of you want to read 5000 words on this fine Monday morning, I've decided it is probably best to break the analysis up into a few reports. So today, I thought we'd start with the economy and corporate earnings...

The State of the Economy

The U.S. economy can be broken down into three components: manufacturing, the consumer, and government. However, the consumer (aka the services sector) is the 800-pound gorilla here, as the spending patterns of John and Jane Q. Public account for something on the order of 70% of economic activity in the good 'ol USofA.

As such, we don't need to worry too terribly much about the state of the manufacturing sector, which has been stuck in a slowdown for many moons now. Yes, it would be nice to see a pickup at some point in this arena, but again, the mood of the consumer remains the key to economic growth these days.

It is also worth noting that high income earners dominate consumer activity today. According to the reports I've seen, the "have's" now control a bit more than 50% (a record high) of all spending in the U.S. The key here is the wealthy don't really care if things cost a little more, they just keep on keepin' on with their lives. In other words, a little inflation isn't going to change the spending habits of those that dominate consumer spending.

Yes, the labor market has weakened, which arguably should affect consumer spending at some point. However, from what I've seen, the weakness in the jobs market appears to be impacting the lower income consumers more at this stage. To be sure, this situation is fluent. If job losses start to pick up, then the services sector would surely be impacted. But so far at least, this does not appear to be the case.

The bottom line here is despite all the negative headlines, the economy appears to be doing just fine, thank you. We should note that U.S. GDP advanced nicely last year going from a slight contraction of -0.6% in Q1, to +3.8% in Q2, and +4.3% in Q3.

And in the near-term, the Atlanta Fed's GDPNow gauge (a real-time estimate of GDP) hit +5.4% last week. Wow!

So, from my seat, anyone trying to argue that the economy is weak and/or on poor footing is simply ignoring reality.

Corporate Earnings

It is said that earnings are the life blood of the stock market. Thus, it is mission critical to stay up to speed on the state of corporate earnings. Cutting to the chase, corporate earnings are strong. As in quite strong.

Exhibit A here would be Q3's results, which came in with a gain of around 15% - MUCH stronger than analysts had expected.

Looking ahead, Exhibit B is the consensus estimates (an average of all Wall Street analyst's projections) for earnings of the S&P 500's companies for 2026 currently sports a growth rate of... wait for it... +17.3%. Yowza.

Granted, the analysts NEVER get the projections right. And typically, the estimates tend to start off too high and decline over time. As such, we would be foolish to count on the idea that 2026 EPS will come in exactly 17% higher than last year.

No, the key point is that EPS is expected to grow at a robust rate this year - a rate well above average. (Goldman Sachs just published a report titled, "2026: An Earnings Story.") So, my take is that as long as earnings come in reasonably close to expectations, stocks should have ample room to move higher.

Room to Run?

The question, of course, is how much room do the indices have to run? While we'll get to the subject of valuations in the next week or two, I think everyone on the planet is aware that stock multiples are rich right now. For me, this explains why Wall Street analyst projections are actually quite modest (in the 10% range, which by the way is very close to the S&P’s average gain since 1980) for the coming year - especially considering the expected growth in earnings.

So... With the economy looking to be in good shape and earnings expected to rise in a meaningful way, it is VERY hard for me to be negative on the stock market.

Sure, this may be a situation where curbing one's enthusiasm regarding the market’s upside here given the valuations might make some sense. But from a big-picture standpoint, I believe the best plan is to remain seated on the bull train and to give our heroes in horns the benefit of any doubt when issues arise in the near-term.

Thought for the Day:

What shapes our lives are the questions we ask, refuse to ask, or never think to ask. -Sam Keen

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES