The US economy continues to be resilient! Inflation has moderated from its highs but is sticking in the upper 2’s. Unemployment is creeping up but still healthy from a historical perspective—50,000 monthly job adds is the new breakeven number. And gross domestic product (GDP) is unequivocally strong, reaccelerating in the back half of 2025.
The stock market is humming along; any dips get filled, quickly. The S&P 500 was up 86% cumulatively between 2023 and 2025. Another low double-digit increase in 2026 and the market will have doubled in four years! So, there’s ample reason to be bullish on US equities, in part due to the macro numbers but primarily because of the enormous potential of emerging technologies.
Exciting times for sure, but it’s always a useful exercise to examine what could trigger a lasting drawdown. This is not a permabear predicting collapse—the bears are always certain, but often wrong. This is a search for reasons why the market could trade at 18x instead of 23x forward earnings, closer to its historical average.
#1: The Obvious
Investors grow tired of waiting for artificial intelligence (AI) to diffuse beyond the Magnificent Seven[1] other sectors and industries. If the earnings multiple is a barometer of investor sentiment, the longer the wait for real-world AI benefits, the more likely positive sentiment will begin to wane.
#2: Non-Consensus AI View
Historically, technology gets smaller, cheaper and more powerful – with improved computing power. If that pattern follows, we wouldn’t need as many data centers as forecast. Or, power supply could prove to be a big enough chokepoint to restrict the buildout of these data centers. There will be winners and losers under a fewer data centers scenario, but it could be a net negative, given AI capital expenditures contributed a material amount to 2025 GDP growth.
#3: Wealth Effect
Real estate and stock markets at all-time highs are exacerbating the wealth effect. People feel well-off, so they spend money, pushing up company earnings, which leads to higher stock prices, which reinforces the wealth effect and the cycle circles around again.
Real estate prices could break the cycle. Housing affordability is a problem driven more by supply than demand. The US is short almost five million units, according to estimates.[2] Eventually supply will catch up—every shortage becomes a glut. Maybe politicians will “encourage”[3] a faster buildout via more lax regulation, lowering real estate values and weakening the wealth effect.
#4: K-Shaped Economy
Consumption is being driven by too few people. Moody’s claims the top 10% of US earners account for 50% of all consumer spending.[4] A perfect example of this is that Delta Air Lines expects all current-year seat growth to come from the premium sector, and none from the main cabin.[5] A broadening of those consuming would probably make for a healthier picture, but strictly from an economic viewpoint, it’s possible this is more feature than bug—as long as the top half of the K spends.
Additionally, there are countless Black Swans, not to mention a federal debt and deficit that’s crowding out more useful spending. There’s also the chance that China or Japan could dump Treasuries, driving up the 10-year yield, or another episode of geopolitics triggering the “sell America” trade.
One of these scenarios may come to pass! Every year has its drawdowns, often in double digits, and the market is rich. High returns on earnings and record profit margins are valid reasons for higher earnings multiples. Still, a broad pullback could be healthy at these levels, and that pullback would provide an opportunity to purchase good companies at lower valuations and rebalance portfolio allocations. With AI, blockchain and robotics on the horizon, there’s still ample reason to be bullish on US equities long-term, which only reinforces our belief to stay invested long-term.
— David Layden, Portfolio Manager