Assessing the Structural Case for a Fourth Straight Year of S&P 500 Gains

The S&P 500's current run is a rare feat. The index is on track for a third consecutive year of double-digit gains, a pattern that has only occurred three times since World War II. The returns for these years are staggering: 24.2% in 2023, 23.3% in 2024, and a projected 16% gain for 2025. This creates a cumulative advance of roughly 77.5% since the end of 2022, a pace far above the long-term average. The most recent parallel was the late 1990s, a period that ultimately culminated in the dot-com crash.

This sets up a central tension. After such a powerful three-year streak, the historical average return for the following year has been just 4.6%. That figure is well below the 9.5% average for all years between 1950 and 2024. The pattern is clear: these extended winning streaks often occur late in bull markets, and the subsequent gains-while sometimes positive-tend to be more subdued. The late 1990s, for instance, saw the market continue higher for one to two more years before a severe downturn.

The question for 2026 is whether this is a warning sign to be heeded or a structural template to be ignored. The historical data suggests a market that has been on a tear for three years is due for a breather. Yet the current setup is unique, driven by a powerful new technology cycle. The precedent is not a guarantee, but it is a powerful reminder that exceptional performance often sows the seeds for a more ordinary follow-up.

The Structural Drivers: Policy, Profits, and the AI Engine

The market's trajectory into 2026 hinges on three converging structural forces: a dovish monetary policy shift, robust corporate earnings, and a massive, AI-driven capital expenditure cycle. Together, they form a credible case for the continuation of gains, even if the pace moderates from recent highs.

First, the Federal Reserve is expected to pivot toward easing. After cutting rates by 175 basis points since September 2024, the central bank now operates within a range of 3.50% to 3.75%. The most likely path for 2026 is for the Fed to bring rates down toward closer to 3% over the course of the year. This shift is supported by a new chair expected to be named in January, with leading candidates signaling a more dovish stance. A lower-for-longer rate environment reduces the cost of capital for businesses and investors, providing a direct tailwind for risk assets.

Second, corporate profits are forecast to remain a powerful engine. Analysts project S&P 500 earnings per share will grow around 10% year over year in 2026. This growth is expected to broaden beyond the Magnificent Seven, with the rest of the index accelerating into the mid-teens by year-end. This resilience in bottom-up estimates, even as forward P/E multiples remain only marginally higher than at the start of the year, suggests market gains are being driven by fundamental profit expansion rather than valuation bubbles.

Third, and most transformative, is the AI infrastructure investment cycle. The hyperscalers-Microsoft, Alphabet, Amazon, Meta, and Oracle-are expected to log combined capital expenditures of more than $500 billion next year, with AI infrastructure accounting for the majority of that spending. This isn't speculative R&D it's a massive, near-term capital outlay that is already being funded by the cash-generative power of their core businesses. This spending cycle directly supports the earnings growth forecast by driving demand for chips, data centers, and cloud services.

The connection between these pillars is clear. Dovish policy lowers the hurdle rate for this massive capex. The resulting AI-driven productivity and revenue growth then fuel the earnings expansion. In turn, strong profits justify the capital intensity and support equity valuations. This creates a self-reinforcing cycle. For investors, the setup is one of structural support: a supportive policy backdrop, a resilient profit engine, and a transformative technological investment wave all aligning to provide a credible foundation for market continuation.

The Concentration Risk and Valuation Headwinds

The bull case for the Magnificent Seven rests on a foundation of immense concentration, a structural shift that now defines the entire market. The group now accounts for 35% of the S&P 500's value, a staggering weight that amplifies systemic risk. This isn't just a tech story; it's a market story. When the performance of the index is dictated by a handful of companies, the concept of broad diversification erodes. As one strategist notes, the "set-it-and-forget-it" approach to index investing is no longer as applicable because portfolio returns are now heavily dependent on the success of these few AI-linked giants.

This concentration is compounded by stretched valuations. The S&P 500 trades near its highest forward price-to-earnings ratio of the last decade. Such levels leave minimal room for disappointment. The optimism baked into prices is immense, pricing in flawless execution of AI investments and sustained earnings growth. As one analyst puts it, the optimism priced into markets doesn't leave a lot of room for disappointment. This creates a precarious setup where any stumble by a key player or a slowdown in the AI capex payoff could trigger a sharp re-rating.

Adding to the uncertainty is the political calendar. 2026 is a midterm election year, and historical data shows a pattern of pre-midterm election underperformance. The S&P 500 has averaged just 0.3% annual return in the 12 months before a midterm election, well below its long-term average. While the underlying economy is the dominant factor, the period is typically marked by policy uncertainty that can dampen risk appetite. For a market already leaning on a few names and high expectations, this cyclical headwind is a material overhang.

The bottom line is a market at a crossroads. The structural shift toward AI and mega-cap dominance has delivered spectacular returns, but it has also created a fragile equilibrium. With valuations at peaks, concentration at record levels, and a historically volatile pre-election period ahead, the path for continued gains looks increasingly narrow. The bull case requires not just continued AI success, but a smooth political transition and a resilient economy to justify the current price. Any deviation from that script could be sharply punished.

Catalysts, Scenarios, and What to Watch

The path to a fourth consecutive year of gains hinges on a few critical forward-looking events and metrics. The primary catalyst is a sustained acceleration in corporate profits, which has driven the market this year. Analysts forecast S&P 500 earnings per share will grow around 10% year over year in 2026, with the broader index expected to grow earnings by 15% next year. This profit momentum is the engine that will support equity performance, but its sustainability is the key risk.

A major near-term catalyst is the Supreme Court ruling on tariff powers, expected in January or February. This decision will provide short-term clarity for manufacturers and markets. While the base case suggests the ruling may repeal the IEEPA tariffs, offering temporary relief, the administration has signaled it will swiftly rebuild trade barriers. The outcome is likely to trigger sentiment swings rather than a lasting policy shift, but it will be a key test of regulatory stability early in the year.

Equally important is the breadth of the rally. The market's strength has been concentrated in the Magnificent Seven, but for the advance to broaden and gain durability, earnings growth must accelerate across the rest of the S&P 500. LPL Financial forecasts that while the Magnificent Seven's earnings growth holds steady in the mid-teens, the rest of the S&P 500's growth accelerates into the mid-teens by the fourth quarter. A widening gap between tech and the broader market would signal a fragile, narrow-based rally vulnerable to a sector rotation.

The ultimate risk to this setup is a sharp deceleration in the AI capex cycle. The hyperscalers are expected to log combined capital expenditures of more than $500 billion next year, with AI infrastructure accounting for the majority. This spending is a bet on future revenue, but the incremental earnings required to justify it are enormous. As one strategist noted, "these numbers are not sustainable" if returns falter. A policy-driven economic slowdown, perhaps triggered by a reversal in the tax and spending bill or a more hawkish Fed, could also compress margins and slow the profit growth that is the market's foundation.