Richard Hunter is head of markets at Interactive Investor.
Last year we asked, in our annual acronym, if the future would be DIGITAL.
We noted the factors of the Dollar, Inflation, Growth, Interest rates, Tariff, Trump and trade wars, AI reckoning – or more to come? and Large caps versus small caps as potentially being the year’s main drivers.
And, indeed, most of those factors had a large part to play.
This was achieved despite increasing
Liberation Day, AI valuation and investment fears, and central banks’ relative inertia on interest rates.
At the time of writing, the Dow Jones Industrial Average in the US has risen by 11.5 per cent in the year to date, the S&P500 by 15.8 per cent and the Nasdaq by 20.2 per cent, with each having tested record highs on many occasions during the year.
Similarly, in the UK the FTSE100 broke through the record high ceiling several times and has currently added 18.8 per cent.
This year we ask – will 2026 bring CHAOS to the markets or could there actually be some CALM?
Will 2026 bring CHAOS to the markets or could there actually be some CALM?
Concentration risk
Hard landing
Asian uncertainty
Overvaluation
Shift in investment behaviour
or
Currency weakness
AI-powered innovation – and payback?
Lower interest rates
Magnificent Seven growth continues
These factors could well influence investors and are as follows –
Concentration risk
Richard Hunter is head of investment at Interactive Investor
This is something which has lingered in the minds of investors and recently showed itself when AI investment began to be questioned.
It is currently estimated that the ‘Magnificent Seven’ stocks account for 35 per cent of the entire market capitalisation of the S&P500, compared to around 12 per cent in 2015. As such, a downward rerating of the mega cap tech sector would have a damaging effect on the market as a whole.
Hard landing
The barbs directed at the Federal Reserve Chair by the President relate to whether the central bank has been too slow in lowering interest rates.
Inflation and of late a government shutdown muddied the waters for the Fed in terms of visibility, where there are some emerging cracks. The labour market is weakening, consumer confidence is low and there is an increasing level of debt which could overburden individuals and the government alike.
While the situation appears under control for the moment, any lurch towards recession would inevitably cast a long shadow over the market’s ability to grow.
Asian uncertainty
The relationship between the US and China, the world’s two largest economies, is fractious at best. Over the course of this year, tariff tensions between the two powers have been heightened, with only the occasional glimpse of a respite.
In addition, and of late, geopolitical relations between China and Japan have worsened following a growing dispute over Taiwan.
With Chinese authorities warning its citizens not to travel in Japan in light of a potential military response should it decide to attack, investors will remain on edge.
While shares in the likes of the retail and travel companies bore the initial brunt, any further deterioration would weigh heavily on sentiment.
Overvaluation
For some, the speculative phase in the US market has peaked, meaning that attention naturally turns to the level of profit growth against ever-increasing expectations.
The S&P500 currently trades at around 30 times earnings, almost double its historic average. The cyclically adjusted PE, or CAPE ratio, which uses a 10-year, inflation-adjusted average to smooth out peaks and troughs, is even higher at 39 times.
Of themselves, these ratios do not signal an inevitable correction to come, although such odds are increasing.
That arguably the world’s greatest and soon to retire investor Warren Buffett had been trimming some of his holdings and sitting on an uninvested cash pile of more than $340 billion also raised eyebrows throughout the year.
Over the course of this year, tariff tensions between the US and China have been heightened, with only the occasional glimpse of a respite.
Shift in investment behaviour
Much as bull markets can be driven by momentum, investor FOMO (fear of missing out) and overconfidence, investor shifts can be equally important in the other direction.
Should the landscape change for the worse, markets could see momentum in reverse, with the herd mentality kicking in as investors rush for the exit at the same time. This can also lead to emotional responses and in turn risk aversion.
However, there could be some rather more positive issues to consider.
Currency weakness
Of itself, currency weakness is of course not a positive although perversely it can act to the benefit of the FTSE100 as has been seen in more recent times.
This is due to the fact that around 70 per cent of earnings are derived from overseas, and much of that from the US. A weaker sterling should, in theory, benefit dollar-earnings companies whose profits become more valuable on repatriation.
In addition, at undemanding valuation levels (the FTSE100 trades on around 14 times earnings compared to the S&P500’s 30 times), the raft of strong, stable companies with relatively high dividend yields could yet be further recognised.
AI-powered innovation – and payback?
In much the same way that investors have fretted around the hundreds of billions of dollars which have been invested in AI to date and over what time period they may be repaid (if at all), any early signs of payback for this financial faith would be extremely well-received.
Although the general term AI is used in everyday language, there are already applications which are less well-publicised, but which are revolutionary.
These can range from detecting cancer or heart disease through reading medical scans and genetic sequences at a level of speed and accuracy previously unknown, to removing language barriers – an eternal human divide – by instant translation based on deep knowledge of various tongues.
Lower interest rates
Even if central banks in the US and UK have been too cautious in easing monetary policy given lingering inflation, the tide seems to be turning, not least of which is due to labour markets which are beginning to suffer on both sides of the pond.
Whereas higher interest rates make it more difficult to justify higher valuations, since they reduce the present value of future profits, they may also limit smaller companies’ propensity to borrow and thus grow their businesses. Lower interest rates could therefore release the ‘animal spirits’ which many investors have been longing for.
Magnificent Seven growth continues
On the flipside of overvaluation concerns is the possibility that the major drivers of growth over recent years continue to deliver, even against the elevated levels of expectation which have now become the norm.
It is estimated that big tech earnings expectations rose by 12 per cent this year, compared to a 6 per cent decline for the rest of the market. ‘Magnificent Seven’ annual earnings growth of 15 per cent is now expected for the next two years and of 10 per cent for the rest. If this compelling growth continues to be delivered, prices will be marked up accordingly, notwithstanding the occasional shock or disappointment.
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