Staying focused on the fundamentals through the noise

Key Points:

• In search of the catch-up trades as Q4 2025 earnings season set to begin
• Wall Street strategists calling for an average gain of 9% for U.S. equities by year-end 2026
• Notable drawdowns historically during U.S. midterm election years, but solid equity returns one-year after

Summary

2026 begins with U.S. equities seeking a fourth straight year of double-digit returns. This has not happened since the late 1990s when the Nasdaq-100 Index® (NDX®) averaged annual returns of nearly 59% from 1995 to 1999 and the S&P 500’s average annual return during that period was over 26%.

Of course, the fundamentals of the market leaders during the last technology revolution are vastly different from today’s mega cap tech leaders. Yet investors will continue to question the repeatability of recent market returns as, per our friends at Nasdaq Dorsey Wright, this is only the third time since 1929 that the S&P 500 has had three consecutive years of 15%+ returns. Investors will also continue to debate whether equity leadership can broaden within the U.S. and globally. Please see our prior piece for more insights.

As of the end of 2025, Wall Street U.S. equity strategists were forecasting an average gain of 9% for U.S. large cap equities by the end of 2026. While the markets tend to have surprises in store for investors and the path is rarely linear, this is nonetheless a healthy return forecast and an example of the broadly positive outlook for risk assets this year.

Our core fundamental thesis for the positive outlook for U.S. risk assets over the next 6 to 12 months remains broadly intact, with the main drivers including: a solid corporate earnings backdrop, supported by a relatively resilient economy—albeit one with a weakening employment picture—and the AI theme, fiscal stimulus in 2026, and ongoing deregulation. These dynamics are further supported by accommodative financial conditions and lower Fed rates. The near-term risks include: labor market weakness manifesting into broader economic weakness, AI capex momentum concerns escalating which would likely compress relatively elevated U.S. equity valuations, the Federal Reserve countering expectations and pivoting more hawkish, a return of macro volatility akin to April 2025, broader geopolitical concerns, and/or volatility heading into U.S. midterm elections in November 2026.

Biweekly Chart in Focus: 3-year rolling equity returns

Source: Bloomberg. Notes: based on monthly returns as of 12/31/25

Details

Catch up trade

We discussed key tailwinds for the select universes above throughout 2025 (e.g., relative valuations, expectations for broadening earnings growth, accommodative financial conditions, stable U.S. economic backdrop), so we will not delve into the details here. However, it is also informative to look at longer- and shorter-term relative price performances. Per our Biweekly Chart in Focus, the 3-year rolling return of the

Nasdaq-100 Index® (NDX®) was 131% at the end of December 2025—outperforming the other equity cohorts in the chart above by 68% to 90%. Outside of the Covid-19 snapback period, this rate of return is on par with the 3-year period following the lows in February 2009 during the Global Financial Crisis. To put this into further context, outside of these two episodes, one would need to go back to late 2000 for a greater 3-year rolling return.

Focusing on the tactical relative price returns, Figures 2 to 5 show the above universes relative to the Nasdaq-100 (as the megacap tech proxy) on a 6-month rolling basis. (We included the Nasdaq KBW Bank Index as a cyclical and value factor proxy.) While all of these equity universes are relatively higher on a rolling 6-month basis and above the 10-year average, only the EM equity proxy (EEM) is outperforming by more than +1 standard deviation relative to the average. So, the recent level of outperformance on a short-term basis is within recent ranges.

While much ink has been spilled about elevated U.S. large cap valuations relative to their longer-term history (e.g., 10 years), and to international markets and the U.S. small cap universes, the Nasdaq-100 forward P/E ratio is effectively in line with its 5-year average and is at the same levels as in September 2024 (Figure 6). U.S. equities are at new or remain near their highs, but earnings have continued to grow as well, keeping forward P/Es in-check. E.g, the Nasdaq-100 rose by 2.3% in Q4 2025 and NTM EPS rose by 8.7% during the quarter—leading to a decline in the NTM P/E of nearly 6% to 26.2, Additionally, the Nasdaq-100’s total return of 21% in 2025 was driven almost entirely by EPS growth.

Figure 6: Nasdaq-100 next 12-month P/E & 5-year average

Source: Bloomberg

Figure 7: Q4 2025 S&P 500 sector earnings growth YoY%

Source: FactSet

Figure 8: A broadening of S&P 500 sector EPS growth expected in 2026

Source: FactSet

Figure 9: Wall Street U.S. equity strategists’ 2026 outlooks

Source: Bloomberg. Notes: based on 21 forecasts for 2026 year-end targets & 20 for 2026 EPS forecasts

A historical look at equity returns during & after U.S. midterm election years

Of course, investors cannot simply look at price returns and forecasts and expected EPS growth in a vacuum—particularly in today’s ever-shifting geopolitical and policy backdrop. Equities near all-time highs can breed complacency: equity volatility is back under 15 on the VIX and recently hit a 1-year low. The markets take what was once abnormal and a threat to risk assets as being the new normal (e.g., trade tariffs). Attempting to time and trade around policy and political events is usually a mistake for investors—e.g., the Nasdaq-100’s almost 49% appreciation from the trade tariff-induced April 2025 lows and how U.S. government shutdowns end up having a minimal impact on equities (see Figure 11 in our October 14th report). It is important to look through the short-term noise and focus on the fundamentals.

That said, with 2026 being a U.S. mid-term election year, appreciating that there are other factors at play throughout a given year, investors should nevertheless be aware of historical trends. (Polymarket currently shows a 78% probability that the House flips to the Democrats and a 67% chance that the Senate stays Republican-controlled.)

• Figure 10 shows the largest S&P 500 intra-year drawdown of a midterm election year since 1942—average of -18%.
• Figure 11 shows the price returns during a midterm election year since 1942—average of 4.2%
• Figure 12 shows the 1-year forward returns after each midterm election day since 1942—average of 14.8%.

Figure 10: Largest S&P 500 intra-year drawdown during a U.S. midterm election year

Source: FactSet

Figure 11: S&P 500 price returns during a U.S. midterm election year

Source: FactSet

Figure 12: 1-year forward S&P 500 returns after U.S. midterm elections

Source: FactSet

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