Assessing the 2026 Market Landscape: The End of the Everything Rally or a New Phase?

The 2025 rally was a historical outlier in its breadth and magnitude. For the first time since the pandemic, all major asset classes delivered positive returns. The standout performers were precious metals, which saw the Bloomberg precious metals index return 80.2% over the year, and emerging markets, which delivered 34.4% in dollar terms. This "everything rally" was not a single-theme event but a rare alignment of powerful forces: persistent geopolitical uncertainty, a shift toward easing financial conditions, and the dominant, multi-year AI innovation cycle that drove technology stocks and broader risk appetite.

This environment created a powerful tailwind for risk assets. Developed markets shrugged off a sharp early-year sell-off, with the S&P 500 ultimately ending the year up 17.9%. Global bonds also posted solid gains, returning 8.2% in dollar terms, as central banks continued policy normalization. The rally's strength was underpinned by a unique combination of stimulative policy, a weakening dollar, and the AI-driven capital expenditure boom that kept corporate investment robust.

Yet, beneath this surface of universal gains, a notable fragility persisted. The rally masked underlying stress in credit markets. Even as high-yield bond spreads compressed, signaling improved risk appetite, the fundamental health of that debt continued to deteriorate. Default rates in high yield bonds continued to edge up throughout the year. This divergence between tight spreads and rising default rates is a classic warning sign of a market that is pricing in perfection while ignoring deteriorating fundamentals.

The bottom line is that the 2025 rally was a powerful, but structurally fragile, phenomenon. It was driven by a potent mix of geopolitical flight-to-quality, monetary easing, and a transformative technology cycle. For institutional investors, the key takeaway is that this breadth may not be sustainable. The rally has compressed risk premiums and elevated valuations, leaving the market vulnerable to a reassessment of those underlying credit risks and the durability of the AI-driven growth narrative. The setup for 2026 is therefore one of high expectations against a backdrop of latent fragility.

The 2026 Investment Thesis: AI as the Primary Tailwind, But at What Cost?

AI is the undisputed defining theme for equity markets in 2026. This consensus is near-universal across the institutional landscape. Fidelity International calls AI "the defining theme for equity markets", while the BlackRock Investment Institute says the tech will likely "keep trumping tariffs and traditional macro drivers." The expectation is for AI to fuel a powerful engine of economic expansion, with even cautious firms like BCA Research staying neutral on stocks due to the risk of missing this transformation.

The most concrete market forecast comes from Goldman Sachs, which sees AI adoption providing the fundamental base for a continued bull market. The firm projects the S&P 500 to deliver a 12% total return in 2026, supported by a 12% increase in earnings per share. This forecast assumes healthy economic growth and a dovish Federal Reserve, with the AI productivity boost expected to drive corporate profits.

Yet this bullish setup carries a significant overhang. The massive capital expenditure required for AI adoption is a double-edged sword. While it fuels near-term growth, it also increases corporate leverage and raises the specter of diminishing returns for first-movers. This capital-intensive build-out creates a structural risk that could pressure margins and earnings quality down the line, potentially undermining the very earnings growth that supports today's elevated valuations. For institutional investors, the thesis is clear: AI is the primary tailwind, but the cost of harnessing it introduces a new layer of financial and operational risk to monitor.

Sector Rotation and Portfolio Construction in a High-Valuation Environment

The 2025 rally's style dynamics were a study in divergence. While growth stocks outperformed in the US, value styles led in most other developed markets, resulting in remarkably similar global returns of 21.3% and 21.6% respectively. This pattern suggests a market where the search for yield and value has been a persistent, if temporarily overshadowed, theme. As we enter 2026, that dynamic is poised to reassert itself. With the AI-driven growth narrative now fully priced in, the institutional focus will likely shift toward identifying the next source of alpha: value stocks.

This rotation is not a mere tactical trade. It is a structural response to a market environment defined by record concentration and elevated valuations. The S&P 500 now trades at a forward P/E of 22x, matching the peak of 2021 and approaching the bubble-era multiple of 2000. More critically, the top tech stocks accounted for 53% of the S&P 500's return in 2025. This extreme concentration embeds significant idiosyncratic risk, making the portfolio's fate overly dependent on a handful of names. In this setup, a "conviction buy" approach is essential. The primary risk is no longer missing AI exposure-it is misallocating capital within it.

The intensifying competition and spending intensity around AI adoption will inevitably pressure margins and earnings quality for many participants. For institutional investors, the path forward requires a disciplined rotation away from the most crowded, expensive growth bets and toward sectors and companies where valuations offer a more compelling risk premium. The goal is to build a portfolio that captures the AI tailwind while de-risking against the fragility of a market that has priced perfection.

Catalysts and Risks: The Watchlist for 2026

The institutional playbook for 2026 hinges on monitoring a specific set of catalysts and risks. While the AI tailwind provides the primary directional signal, the market's path will be determined by the interplay of three key watchpoints.

First, Fed policy and economic data remain the central macro lever. The current setup assumes a dovish Fed and steady growth. Goldman Sachs forecasts US GDP to grow 2.7% this year and the Fed to make two rate cuts, which would support the market's elevated multiples. However, the market's high valuation-trading at a forward P/E of 22x-makes it sensitive to any deviation. The primary risk is a hawkish pivot or weaker-than-expected growth, which could abruptly change the risk premium. For portfolio construction, this means the institutional focus is on liquidity and duration management, as the market's ability to sustain its rally is directly tied to the durability of this supportive policy environment.

Second, AI capex spending trends and corporate earnings quality are the fundamental test of the AI thesis. The optimism is universal, but the payoff is not guaranteed. The massive capital expenditure required for AI adoption is a double-edged sword, as it fuels near-term growth while increasing leverage and raising the specter of diminishing returns. The watchpoint here is whether this spending translates into the promised productivity boost and, crucially, into sustainable profit growth. As noted, "AI capex trends are themes to watch" because the earnings growth underpinning the 12% S&P 500 forecast must materialize. Any sign of margin compression or earnings disappointment would directly challenge the market's high valuations and could trigger a rotation away from the most expensive growth names.

Third, geopolitical flare-ups and trade policy shifts represent the conventional, yet persistent, risks to the current risk-on flow. While the AI boom and supportive policies provide a powerful counterweight, these are not new risks. As one outlook notes, concerns over geopolitics and trade barriers remain among the worries. A sudden escalation could disrupt global supply chains and reignite volatility, acting as a catalyst for a flight to quality that would test the market's breadth and the strength of the AI narrative. For institutional investors, this underscores the need for a portfolio that is not solely reliant on a single theme, maintaining some exposure to defensive assets and sectors less sensitive to external shocks.

The bottom line is that 2026 is a year of high conviction in a specific theme, but low conviction in the stability of the supporting environment. The watchlist is clear: monitor the Fed's patience, the quality of the AI earnings payoff, and the geopolitical temperature. Any one of these could shift the risk-reward calculus for the entire market.