By Tim Courtney, Chief Investment Officer

As we start 2026, some of the same circumstances that shaped 2025 will influence this year’s market behavior. These issues remain central as we move through the first quarter. 

Interest rates: The direction of interest rates remains an important variable for markets. At various points last year, markets priced in multiple cuts, then walked those expectations back. We did see a cut in September, and for a time the market assumed more were coming.¹ That confidence faded in the second half of the year as inflation settled closer to 3% rather than the Fed’s 2% target.²

Our view has been consistent. The Federal Reserve (Fed) was far too accommodative in 2020 through early 2022, and the rate hikes that followed were an attempt to correct that mistake.³ Inflation has come down meaningfully from its peak, but it remains elevated.³ Interest rates probably should be steady when inflation is above target and lowering purchasing power.

It is also important to distinguish between what the Fed controls and what the market controls. The Fed influences short-term rates, but longer-term rates, such as 10- and 20-year yields, are largely set by the market.⁴ Those longer-term rates affect borrowing costs, valuations and investment decisions across markets.⁴ Investors might welcome lower rates, but equities are already fairly expensive.⁵ Rate cuts can support prices, but too much easing risks reigniting inflation and undermining real long-term returns.⁶

Economic growth: Economic growth has been slowing for some time, and that has largely been by design. The massive stimulus deployed in 2020 and 2021 pushed money into the economy at an unprecedented pace, boosting growth and inflation.⁷ Over time, those effects wore off, and higher interest rates have done what they were intended to do.⁸

A slowdown may tip over into a recession. Some data continues to show resilience, while other indicators point to rising stress.⁹ Default rates have moved higher,¹⁰ consumers appear to be reaching the end of the rope in certain areas, particularly with credit card balances and auto loans, and job growth has moderated.¹¹

The Fed has put itself in a difficult situation. They will have to set rates with an eye towards both fading growth as well as above target inflation. The economic data is noisy, but we may learn how far away we are from a recession later in the quarter.

AI productivity: The third area we are watching closely is whether AI is starting to deliver. The amount of investment in AI has been immense and unprecedented, particularly as data centers are being built at a rapid pace.¹² These projects are consuming electricity, land, water, liquid capital, talent, and time all across the economy. 

More recently, experienced investors have begun to question whether the scale of that spending is justified based on expected revenue and productivity gains. There is little evidence of productivity gains in the data thus far.¹³

That disconnect creates risk, as current prices indicate that higher revenues and productivity are a near certainty.¹⁴ Now these companies have to deliver substantial growth and productivity to justify prices.

Taken together, this is a market that is still pricing in a lot of good news while several important questions remain unanswered. In this scenario, price discipline and diversification matter more than narratives or near-term expectations. If you have questions about how these conditions affect your portfolio or would like to discuss specific risks, please reach out to your Exencial advisor.

Sources:

1. Morningstar (9/17/25) - Fed cuts rates and signals more to come in 2025
2. U.S. Bureau of Labor Statistics (12/18/25) - Consumer price index summary
3. Federal Bank of San Francisco (6/24/24) - Anatomy of the post-pandemic monetary tightening cycle
4. US Bank (12/23/25) - How do changing interest rates affect the stock market?
5. CNBC (1/2/26) - Any way you look at it, the U.S. stock market is expensive as the new year begins, BofA says
6. Reuters (12/16/25) - More rate cuts could reignite inflation, hurt Fed credibility, Bostic says
7. Federal Reserve Bank of St. Louis (1/20/23) - Demand-supply imbalance during the COVID-19 pandemic: The role of fiscal policy
8. The Washington Post (11/2/22) - How the Fed’s rate hikes slow the economy — and impact you
9. Bloomberg (12/15/25) - US recession risk is receding as we move into 2026
10. Investopedia (10/29/25) - Consumer loan delinquencies approach 5-year high, borrowers struggle to keep up with payments
11. Reuters (12/10/25) - US labor cost growth slows in third quarter as labor market conditions soften
12. The New York Times (8/27/25) - The A.I. spending frenzy is propping up the real economy, too
13. Fortune (8/18/25) - MIT report: 95% of generative AI pilots at companies are failing
14. NPR (11/23/25) - Here's why concerns about an AI bubble are bigger than ever

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