The S&P 500 rose 16% in 2025, the third consecutive strong annual increase. This allowed the economy to power ahead in spite of the disruptions and uncertainty created by erratic shifts in tariffs policy. The outlook for growth in 2026 is quite favorable given that the powerful wealth effect created by the gains in equity prices will remain in force while the negative effects of tariffs can be expected to gradually fade.
Over the past three years, the annualized gains to the S&P 500 have been 21%. This has been an exceptional period, exceeded in recent decades only by the five-year run that ended in 1999. Both of those stock market booms were powered by investor enthusiasm for new technologies. The technology boom during the second half of the 1990s ended with excesses that could be described as a bubble, the bursting of which contributed to a recession. It remains to be seen if the current boom will end the same. The experience of the late 1990s suggests that the current stock market surge might continue for at least another year or two. When important and exciting new technologies get introduced, it takes time to accurately assess their impact on growth and profits and markets become prone to excesses.
While it will take more time for the benefits from the advances in AI to manifest themselves, the effects of the tariffs have mostly been played out. They have caused prices to be about 0.4% higher than they would have been otherwise, which for the average family of four means a reduction in purchasing power of slightly over $1,000. Along with the uncertainty generated by the erratic way in which the changes in tariffs policy were rolled out, the loss of purchasing power was an offsetting factor to the growth generated by AI-related investment and accompanying wealthy generated by the stock market. While some additional adjustments to supply chains will take place in 2026, the effects of the changes to tariffs policy have mostly been already absorbed by the economy. This means that the drag from these policies is diminishing.
The economy’s great unknown
Another way of putting it is less of a drag from tariffs is a positive for the economy. This makes it likely that GDP will grow faster in 2026 than it did in 2025. Tariffs will also have a smaller effect on inflation in 2026 than they did in 2025. This means that core inflation will likely decelerate in 2026. Energy prices, however, are unlikely to show as large a decline as they did in 2025. Oil prices fell by about $12 per barrel in 2025 and this will be hard to match in 2026.
If this scenario of faster growth and slower core inflation plays out in 2026, the Federal Reserve will have to weigh things carefully. Usually such a combination results in fairly steady policy. However, the Fed is under quite a bit of pressure from the White House to cut interest rates more aggressively. Jerome Powell’s term as FOMC chair expires in May and the president is likely to appoint a replacement whose views are more congenial to his own. This means that issues relating to central bank independence and credibility could move to the forefront in 2026.
Another major source of risk in 2026 is the stock market itself. The current bull market is entering rare territory. It could continue for another year or two, or perhaps even exceed the bull market of the last 1990s in terms of magnitude of gains and duration.
While the stock market and Federal Reserve credibly are two of the biggest known uncertainties for 2026, the biggest risks are probably the unknown unknowns. The things that will happen that no one or very few people expect. That is the case every year. The only certainty is that a current unknown will make itself known and become very important in 2026.
