A Brighter 2026? Policy, Productivity, and the Rate Question

There is some significant good news out there and it is recognized by the marketplace. In a recent survey of the investment industry, virtually all the major houses were bullish for 2026, particularly in the second half of the year. Why?

The One Big Beautiful Bill Act - Benefits for Consumers and Businesses

First, the One Big Beautiful Bill Act (OBBBA) positively impacts both 2025 and years following for the consumer. Here are some of the provisions: 1) an increased standard deduction to $15,750 ($14,600 in ’24) for singles; $31,500 (was $29,200) for joint filers, plus an additional deduction for seniors: $2,000 (was $1,950) for singles; $1,600 (was $1,550) per 65-year-old+ spouse for joint filers.  

So, what does this mean in economic terms? The difference for a joint couple over 65 in 2025 vs. 2024 is about $2,350, representing tax savings of about $500-$600 per couple. This represents at least an additional $500-$600 buying power and more if leveraged.

However, that’s not all: there is an additional, “Senior Bonus” deduction of $6,000 for single filers, and $12,000 for joint filers. What’s important to note is that the deduction can be added to both a standard deduction OR itemized deductions. If fully realized, $6,000 could produce $900 to $1200 in tax savings.

As usual, wealthier individuals have their deduction reduced as their income rises above $75,000 for singles, and $150,000 for joint filers until it is extinguished at $175,000 single, $250,000 joint.

Here again, the additional cash flow helps consumers spend and save, and thus consumers who continue to have jobs, and who get additional cash flow in 2026, can be expected to continue their spending. Our view of the US consumer is, “if they have it (money), they’ll spend it.” And since consumer spending represents about 70% of the economy, there’s probably going to be a relatively strong economy in 2026 with improving corporate profits.

There is good news for business too that applies to 2025 tax returns. Businesses can deduct 100% of the cost of new qualified equipment and buildings placed in service in 2025 or later instead of depreciating them over their useful lives. These provisions should provide substantial additional cash flow from business investment that should also result in improved economic growth because business can afford to spend more on productive assets.

Capital Investment - an AI Boom

Second, we expect continued capital investment as the AI infrastructure buildout accelerates. That includes new data centers, the servers they house, and the power generation and grid upgrades needed to support them. These investments can boost employment and, in turn, consumer spending. Importantly, these commitments aren’t limited to “AI companies”; major spending is also coming from financial services, healthcare, and government.

As for the impact on jobs: AI is creating new jobs, transforming existing roles, and boosting productivity, leading to overall job growth. While many tasks are being automated, causing displacement, many sources predict a net gain in jobs, with significant demand for AI-related skills, even as companies see higher growth and wages in AI-adopting firms. The key trend is job transformation, requiring workers to upskill for roles in data analysis, machine learning, and AI development, with AI augmenting human capabilities rather than purely replacing them. We think an increase in productivity implies at least some improvement in corporate profitability, benefiting stock prices.

Lastly, many countries and companies have pledged to invest in the United States. While the projections are not available for 2026, the rough estimates are expected to rise to 2024 levels of $150-180 billion, an improvement over 2025. This too adds to prospects for growth.

The good news is well known even if the exact numbers aren’t. However, we still have some significant risks.

Geo-Political Risks: Russia

We expect Russian President Putin to disappoint (over and over again) President Trump’s efforts at peace in Ukraine.  While President Trump continues to withhold weapons, we believe Putin’s strategy will be to continue his pursuit until Ukraine is forced to give in. We don’t think this is much of a “peace.” Each time we turn around Putin has increased his demands. We don’t think it stops anytime soon.

We also suspect that behind closed doors, the Saudi’s have agreed to keep pumping oil to gain access to Nvidia’s chips. The lower oil price reduces inflation for President Trump in a run up to the midterms, and it lowers the war financing oil revenues for the Russians. Whether it comes soon enough or lasts long enough remains to be seen.

Inflation

Tariffs have contributed to the higher inflation readings in recent releases, and if tariff policies remain in place for an extended period, their impact on consumer prices may become more visible. Many necessary expenses, such as rent, food, insurance, and cars, remain elevated. The issue is not so much the year-to-year change, but that the overall price level has not meaningfully declined. We expect affordability and inflation to be prominent issues in the upcoming midterm elections. In addition, ongoing labor constraints and stronger economic activity could put upward pressure on inflation. Whether productivity gains from broader AI adoption will be sufficient to offset these pressures remains to be seen.

Interest Rates

Finally, we note that expectations for rapid, steady declines in interest rates have moderated. In the Federal Reserve’s December 2025 Summary of Economic Projections, the median participant sees the federal funds rate ending 2026 around 3.4%, versus 3.6% at the end of 2025. This represents roughly one additional 25 basis-point cut. And if inflation continues running above 2% (the Fed’s “target rate” for inflation) the prospects of further easing become more unlikely.

What is not widely expected is a renewed increase in short-term rates. Fed Chair Powell’s term is up in May, and the consensus is that whomever President Trump appoints in his place will be sensitive to the President’s wishes to keep interest rates lower.

Valuations

At year-end 2025, forward p/e ratios for the “Magnificent Seven” were estimated to be about 31 times 2026 earnings. For the remaining 493 companies in the S&P 500 Index, their p/e was estimated to be about 18-20 times forward earnings. The estimated growth rates for the first group are about 22-23% versus 12%-13% for the larger group. We conclude that the p/e is only ~60% greater with a growth rate that is ~80% higher than the larger group. It’s a rough analysis, but it says that the tech (and AI, in particular) stocks (if the growth rates are accurate) are not necessarily a bad value at this moment.

What to Do?

Because of our contrarian philosophy, we already own substantial positions in three key areas: construction, housing, and energy. We have varying commitments to money market funds depending on individual risk tolerances and sensitivity to capital gains taxes.

We do see potential in adding technology to portfolios where exposure may be somewhat limited. We will never match the S&P 500 Index’s 30-35% allocation unless it is suitable (given a client’s risk tolerance) or requested.

Because many are uniformly bullish, we can only guess that something will crack the optimistic bullishness and therefore we will keep at least some dry powder except in a few cases. We have long thought that interest rates would remain higher for longer but given the Fed’s dual mandate that includes price stability, we can foresee rising inflation causing interest rates to remain somewhat elevated.

Finally, we would observe that a 3% inflation rate and an unemployment rate of 4.6% reflects the average rate of the former over the last 50 years, and the latter is actually very low in the history of the United States. We would say the economy has finally normalized after the “Covid period.”  Nonetheless, given the $38+ trillion government debt outstanding (of which about 25%-32% is held outside the US), a small increase in the interest rate paid (e.g., by 1%) represents a large increase of about $300-$380 billion in the US government’s interest payments over time. Not good for government deficits, interest rates, bonds and the stock market.

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