MARKET HIGHLIGHTS

• The market started 2026 with robust yet narrow sector leadership.
• Market concentration stayed very high among mega-cap technology firms.
• Small caps showed powerful early-year performance and leadership.
• Historical patterns indicate that early small-cap strength often comes before positive years.
• Cyclical and commodity sectors demonstrated renewed strength and leadership rotation.
• Equal-weight indices outperformed, indicating healthier and more widespread market involvement.
• Global stocks experienced significant, synchronized gains across key regions.
• Earnings outlook improved with more substantial revenue and margin forecasts.
• Sentiment stayed high, encouraging risk-taking but also raising vulnerability.
• The Fed has lowered interest rates, which eases overall financial conditions.
• Credit spreads have narrowed and indicate minimal current stress.
  Caa–Baa spreads could narrow further if economic growth accelerates.
• Volatility risks are increasing despite low current MOVE readings.
• Japanese yield increases threaten global rate stability and spreads.
• Term premia stay near long-term averages after recent increases.
• Falling liquidity may flatten the yield curve in 2026.
• Foreign Treasury sales put slight pressure on long-duration bonds.
• Overall markets stay stable despite global and policy uncertainties.

U.S. equities began 2026 with strong momentum, supported by broadening market leadership, rising earnings expectations, favorable macro conditions, and early signs of sector rotation away from overconcentrated mega-cap technology. Looking back over the last year Gold once again led performance, significantly outperforming equities and fixed income, while emerging markets and international equities posted solid gains. U.S. sector leadership remained narrow in 2025, focused mainly on Communication Services, Technology, and Industrials, while defensive sectors lagged—highlighting the importance of a selective investment positioning.

Valuation dynamics remain influenced by the strong performance of real assets. Gold has significantly outperformed equities over the past twenty years, especially during periods of inflation or low real yields. Although equities still provide robust long-term real returns, inflation erosion highlights the need for commodities and inflation-hedging assets within diversified portfolios.

Sentiment indicators have climbed to high levels—close to the 80th percentile—showing optimism but also more limited upside potential. ETF inflows remain robust, with healthy but not overly stretched demand in cyclical sectors. Strategists generally anticipate mid-single-digit to low-double-digit equity gains for 2026. Elevated sentiment supports short-term risk assets but also increases vulnerability to macro shocks.

Looking ahead, seasonality indicates strength early and late in 2026, while a more turbulent mid-year is typical of election-cycle dynamics. Cyclical sectors such as industrials, materials, energy, and discretionary sectors continue to show strong trends and momentum, whereas technology displays mixed performance (semiconductors remain strong, software weak). Defensive and duration-sensitive assets continue to underperform. Market breadth stays healthy, with about 70% of large-cap stocks displaying solid long-term trends.

Key risks include weakening labor market signals—such as negative payroll numbers, declining job openings, and slower wage growth. However, productivity improvements, AI-driven efficiency gains, and strong household wealth provide significant offsets. While near-term GDP growth may slow, resilience in margins and earnings maintains a positive outlook for the broader market.

Credit and funding markets show little sign of stress. Spreads across BBB, BB, and even CCC-rated bonds continue to decline and stay well below six-month highs. This ongoing tightening suggests stable financing conditions and supports risk assets tied to economic growth. The gap between Caa and Baa spreads has narrowed sharply since widening during earlier volatility, but it still remains above levels seen in previous expansions, leaving room for further narrowing if economic growth speeds up in 2026. However, several risks have surfaced. Rising Japanese government bond yields, threats to the Federal Reserve’s independence, and geopolitical tensions have all fueled concerns of renewed volatility. While the MOVE index of Treasury volatility is near multi-year lows, these risks indicate that volatility could rise, likely increasing yields and widening certain spreads, especially in mortgage-backed securities.

Interest rate risk is still mainly driven by term premia, which account for most of the variation in Treasury yields. Term premia have risen about 168 basis points since mid-2023 after demand dropped and coupon supply increased, but they now stay near long-term averages. Foreign central banks have been decreasing their Treasury holdings while increasing gold allocations, creating a slight headwind for longer-term bonds. Meanwhile, liquidity cycles remain important. When global liquidity declines, it usually boosts demand for safe assets and reduces term premia, causing flatter yield curves. Historically, this suggests the U.S. yield curve may flatten by mid-2026, though it may steepen in the near term.

Looking ahead, the overall trend across markets shows improving economic growth in 2026, alongside persistent pockets of rate and volatility risk. While it may still be early to increase long-duration exposure, a shift in liquidity conditions and a normalization of yields could make the middle of the year more favorable for bonds.