Reasons to be bearish and bullish in 2026

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In our last episode of 2025, Kyle is joined by interactive investor’s head of markets Richard Hunter to look ahead to key drivers for stock markets in 2026. Richard shares reasons to be both bullish and bearish, and highlights three areas in the UK stock market that are piquing his interest.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, I’m Kyle Caldwell, and this is On the Money, a weekly look at how to make the most out of your savings and investments.

In the coming weeks at ii.co.uk, we are going to be writing lots of articles looking back at the winners and losers for stock markets, funds, investment trusts, and exchange-traded funds (ETFs) in 2025.

But, for our last podcast episode of this year, I wanted to look ahead to prospects for markets in 2026. Joining me to discuss his investment predictions for 2026 is Richard Hunter, head of markets at interactive investor.

Richard Hunter, head of markets at interactive investor: Hi Kyle.

Kyle Caldwell: So, Richard, each year you come up with an acronym that highlights the key things for investors to watch out for in the year.

Let’s just very briefly cover off 2025’s acronym, which was DIGITAL. So, DIGITAL stood for dollar, inflation, growth, interest rates, tariffs, AI reckoning, and large cap versus small caps.

I do think with lots of the predictions that you made, Richard, you were really on the money as all those factors did influence stock market and investor behavior in 2025.

For me, if I have to pick one, I feel like US tariffs stood out the most in terms of influence, as early this year there was a quite heavy drawdown for the US stock market, and by extension, the global stock market due to the uncertainty and the unknowns over how US tariff policies would play out and how it would impact certain businesses, sectors, and industries.

We now know that we had a very strong stock market recovery play out from early April onwards when US President Donald Trump eased stock market nerves by announcing a 90-day pause on US tariffs.

Now, tariffs don’t form part of your investment acronym for 2026. So, before we get on to that, I wanted to ask you for your thoughts on US tariffs and the risks that they pose for stock markets.

Are tariffs now potentially in the rearview mirror, as we now know a lot more about them? It’s not an unknown unknown anymore. It’s now a known. So, does that mean that they are less of a risk for markets going forward?

Richard Hunter: I think a lot of the sting has been taken out for the reasons that you describe. It’s not to say they won’t continue to be a factor next year. We have had a situation with certain countries in the US where they’ve been able to absorb the kind of effects, and some of this has been passed on to the customer.

And, of course, one of the dangers remains that they are potentially inflationary. We’re also in a situation, certainly in terms of the US, where in terms of the Fed’s dual mandate, they’re now rather more concentrating on the labour market part of the equation rather than the inflation part of the equation.

So, obviously when you realise the world’s largest central bank is less focused on inflation, that should be a good thing. However, that’s not to say there couldn’t be a couple of things that we still need to be looking out for.

For starters, there’s currently a legal challenge going on in the States as to whether the introduction of the tariffs was lawful in the first place. They are meant to be introduced in times of economic crisis, and it will be difficult to describe the US situation as an economic crisis at the moment. So, watch this space as that one unfolds.

And, of course, the other thing is that we’re currently in the middle of a truce in terms of the tariffs between the world’s two largest powers, China and the US. At some point, a decision will need to be made whether to extend that truce or whether to reintroduce a tariff. So, it’s not to say that tariffs are going to go away or the tariff implications are going to go away, but at least we are more aware now of the places to look, which in theory should be less of a market mover.

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Kyle Caldwell: In terms of if you are owning an individual company, you should know by now about whether that business will be impacted by tariffs as they will have had to report it to the market already and informed fellow investors that US tariffs are going to impact us in x, y, and z way.

I’ve seen a number of companies set aside a certain amount of money, or they’ve got across to investors that, actually, tariffs are going to hit us in the pocket by x amount. So, that information should now already be out there and readily available.

Richard Hunter: Yeah, that’s right. And, of course, markets and investors can deal with bad news all day long. They get tested on a weekly, if not a daily basis, but it’s the uncertainty which tends to unsettle investors. Any extra layer of detail is, of course, helpful.

Kyle Caldwell: Let’s now move on to your investment factors to watch in 2026. You’ve slightly broken from position this year, Richard, as I’ve noticed that you’ve now got two acronyms, which are CHAOS and CALM.

So, let’s first run through the more bearish scenario of 2026 bringing chaos to markets. CHAOS stands for concentration risk, hard landing, Asian uncertainty, overvaluation and shift in investment behaviour.

Richard, could you briefly run through each of those?

Richard Hunter: Yeah, for sure.

In terms of concentration risk, which of course has been something of a concern for a little while now, it’s estimated, for example, that in terms of the entire market cap of the benchmark S&P 500, just the Magnificent Seven account for around 35% of that.

The problem with that is we’ve started to hear the expression now, ‘the S&P 493’, as being a place to look, particularly in a slightly easier monetary environment that we’re seeing towards the December 2025.

But as things currently stand, and despite a sort of lessening of the euphoria around the artificial intelligence (AI) trade, the fact remains that there are those seven companies which have a disproportionate impact on the way the market tends to move.

A hard landing, well, the Federal Reserve has just lowered interest rates by a quarter of a percentage point. Some in the market had been calling for more, and more often. In terms of 2026, it seems like there’s only, according to the current Fed projections, probably only one more to come.

Again, the market’s pricing in two or three. The reason a hard landing could be a problem, quite simply, is if the Fed has missed the boat and anything like a slowdown or indeed a technical recession were to take hold.

There’s another interesting development on the horizon as well, which is the replacement of the Fed chair and the current speculation seems to be that whoever the replacement is could be more dovish, which obviously would, all things being equal, lead to more interest rate cuts, more of a boost to the economy.

Asian uncertainty, well, we’ve already mentioned the tariff truce between China and the US. That’s something that’s a fractious relationship at the best of times, so again you can expect ups or downs as we move through. But obviously being the world’s second-largest economy, and indeed Asian markets as a whole do have an impact on global markets, and of late there’s been something of a geopolitical spat between China and Japan around the status of Taiwan.

So, obviously, that’s one to be keeping an eye out for, because emerging markets increasingly have been seen as a potential area for growth.

O is for overvaluation. The S&P 500 is trading on about 30 times earnings, which compares with something nearer half of that for the FTSE 100, for example. Some of that, of course, is around the proliferation of technology stocks and indeed the Mag 7 stocks that we’ve already mentioned.

So, obviously, if stocks are being overvalued, I don’t particularly like the AI bubble comparison with the dotcom boom on the basis that around the turn of the century, many of the companies on a 100 times earnings had failed to make any revenue, let alone profit, whereas a lot of the current AI investment is coming from some of the real mega-caps, the Microsofts of this world, which are taking part of the investment from their existing cash position.

Shifting investment behaviour. Well, as much as you can have the FOMO trade, fear of missing out on the way up, you can also have investors rushing for the door should they see something that really does worry them.

Of course, we’ve not had a real test yet of something any more systemic, I hope we don’t, but despite Liberation Day tariff uncertainty, geopolitical concerns, which have been a feature this year, markets have ended up in a very positive position with the FTSE 100 and the three main US indices posting gains of between 14% and 20% for the year.

Kyle Caldwell: In terms of what investors can practically do to navigate some of those risks, with concentration risk, as you point out, Richard, seven companies account for a very large proportion of the S&P 500 index. But there are various ways to reduce concentration risk.

One of those is to consider an equally weighted ETF. What these ETFs do is own stocks in an equal proportion. So, for the S&P 500 index, they would own 0.2% of each company, rather than the typical market cap weighted approach that most traditional index funds and ETFs adopt.

Of course, with an actively managed fund, you could potentially pair that with a global index fund or a global ETF. But one thing you should really ensure is that the global active fund is investing sufficiently differently from the global tracker fund.

Check that it’s bringing something different to the party, and that it is complementing [your] exposure to the global stock market. It’s really important to look under the bonnet, and understand how the fund’s investing, how it’s seeking to outperform. Is it investing sufficiently differently from the global stock market index? Because if it’s not, then you may not get performance that’s vastly different from the global stock market.

In terms of the points you made there, Richard, regarding whether the US stock market is overvalued or not, there are cheaper regions. One of those is our very own UK market, which is carrying much lower valuations than the US stock market.

Of course, the UK stock market’s not as cheap as it was. It’s had a strong run this year. But, again, if you look under the bonnet, it has been the biggest companies at the top end of the FTSE 100 index that have led the rally.

If you look below the FTSE100 index at the FTSE 250 or the FTSE 350 index, which contain mid-cap and small-cap companies, they are trading on much cheaper valuations relative to larger companies. What are your thoughts, Richard, in terms of where the best value opportunities are at present in the UK stock market?

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Richard Hunter: Well, I think 2025 has seen the UK market come in from the investment wilderness, that it’s been on the global stage for a number of years now. In theory, that should position it well for further growth.

One of the things that has tended to hold the index back has been its lack of exposure to technology stocks. In terms of 2025, that’s been a good thing, not necessarily for good reasons. One of the best-performing sectors has been the defence sector, where government spending has been upped on the basis of some of the tensions we’ve had.

We’ve also had a very good year for the miners and the resource sector in general, not least of which because of a gold price which has been hitting record highs.

We’ve also seen increasing evidence of the strengths of UK banks, particularly compared to pre-financial crisis. In terms of value, and certainly compared to a lot of its global international peers, there is still value to be had at the top table. I would certainly mention UK banks within that, not only the fact of their actual stability, but also their concentration on shareholder returns, whether that be in terms of buyback programmes, because they are or they have excess capital at the moment, or indeed increased dividends.

I think another sector worth looking at - and again AstraZeneca (LSE:AZN) is pretty much the biggest company within the FTSE 100 - is the pharmaceutical sector in general. Their biggest playground, AstraZeneca and GSK (LSE:GSK), is indeed the States.

There is certainly no slowdown in the advances currently being made in the technology space, especially those driven by AI, and while the likes of Astra have had a particularly strong run, inevitably there could be further to go, particularly if a blockbuster drug was to show itself.

I think possibly in terms of a slightly more unloved trade, and again still within the FTSE 100, it could be worth looking towards those stocks with an exposure to China. China has been held back in 2025 for a number of reasons. We’ve already mentioned the US relationship, but they’ve also got a beleaguered property sector, high youth unemployment, and pretty tepid consumer demand as well. If we were to see the authorities step in, as they have done in the past with stimulus, that could be good for China.

The likes of Prudential (LSE:PRU), and even Burberry Group (LSE:BRBY), with that Chinese exposure, could see the benefit.

Kyle Caldwell: In your view, there’s plenty of value still to be had within the FTSE 100, so investors don’t necessarily need to look outside it, towards the more domestically focused companies?

Richard Hunter: They can do that in addition. It really depends on your level of risk. One of the beauties of the FTSE 100 is that it tends to be typified by strong, companies. The average dividend yield is about 3.1% as we speak. If you’re an income investor, there’s an immediate amount of, inverted commas, “almost guaranteed” dividend income that you can take.

If you’re more of a growth or long-term investor, reinvest your dividends and ultimately benefit from compound interest.

Kyle Caldwell: As we talk about a lot on the podcast, there’s always risks associated with markets. I think if there weren’t any risks, that’d be a risk in itself. One way to navigate risk over the long term is to have a diversified portfolio, which we speak about a lot on the podcast.

In terms of setting up that portfolio, it means you have different types of investments, different sectors, different geographies, different asset classes. What this does is it gives your portfolio ample opportunity to grow over the long term, but it also helps to smooth returns when stock markets have periods of weakness, which they inevitably do.

Richard, let’s now move on to the more optimistic scenario in 2026 of stock markets being CALM. So, taking each letter in turn, CALM stands for currency weakness, AI-powered innovation - and payback, lowered interest rates and Magnificent Seven growth continuing.

Could you talk through each of those?

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Richard Hunter: Yeah. I mean, the currency weakness one doesn’t sound like a strength or a positive, but where we’re coming from on that particular point is the often overlooked fact that the FTSE 100 is absolutely full of global companies. In fact, it’s estimated that around 70% of the entire earnings of the index come from overseas, and from the likes of the States in particular.

So, should we get a weaker sterling from lower interest rates, if that were to happen in the UK, other currencies would strengthen. If you only get one interest rate cut in the States, then the dollar, all things being equal, shouldn’t weaken too much further.

But, if the dollar regains its strength, particularly its haven status, it means that earnings are more valuable for those companies because the value of those earnings is worth much more on repatriation. So, counterintuitive though it might sound, currency weakness can actually be good for the FTSE 100 and its constituents.

AI powered innovation - and payback. Well, at some point, the hundreds of billions, if not trillions, of dollars of investment, we’ve seen being ploughed into AI, is going to need to show its face in terms of whether that money has been over-invested, or if it hasn’t, what sort of time frame we’re looking at for payback.

Now, perhaps some of the actual advances that are being made from AI, particularly in the healthcare sector, where some of the advances are quite extraordinary, the likelihood of personalised medicine is no longer science fiction, for example, it’s coming nearer and nearer because of the amount of data that can be crunched. There are all sorts of other innovations coming through, which should make the world a better place.

The question is whether some of these get highlighted next year, that could ease a lot of the concerns that investors might have around over-investment, when it can be demonstrated that there are real, everyday benefits already starting to wash through.

Lower interest rates is fairly self-explanatory. It seems that the Bank of England is going to have to be forced at some point to recognise that while inflation is a bit stickier than it would like, the UK is a flailing economy and it’s badly in need of a shot in the arm, and the easiest tool that it has at its disposal would simply be to lower interest rates. So, all things being equal, that should inject some life, not just into the FTSE 100, but probably even more so into the FTSE 250.

Even at the lowest end of the capitalisation index, smaller businesses tend to borrow more in order to grow their businesses, needless to say, lower interest rates, lower borrowing costs.

Finally, the Magnificent Seven. Well, what if all those things come together? We start to see AI payback. They continue to live within their economic moats, they continue to break barriers down in terms of revenues that they are currently achieving through not only AI growth, but also the amount of money they’re making from cloud and so on.

So, it’s not inconceivable, even if they are overvalued, it’s not inconceivable that the Mag 7 growth could actually continue, which would obviously put a fairly strong foundation under the market and indeed global sentiment for the entirety of the year.

Kyle Caldwell: I’m going to end with a couple of thoughts on AI. It’s a key question at the moment and, as you’ve mentioned, Richard, there are some concerns, including the amount of money some of the world’s biggest companies are spending on AI, whether they are spending too much, and whether in future they’ll actually get it back in terms of making enough money from the investments that they’re making.

We interviewed a number of fund managers in our Insider Interview video series, which you can check out on our YouTube channel. We interviewed six fund managers in total, with them looking back at how stock markets have performed, or how the area that they invest in performed, in 2025. They also looked ahead to prospects for 2026.

I asked both Gabrielle Boyle, a fund manager at Troy, and Ian Rees, a fund manager at Ruffer Investment Company (LSE:RICA), for their views on whether the huge amounts of money being spent on developing AI applications is giving them cause for concern.

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They both stressed the importance of keeping a close eye on whether valuations and the share prices for AI-related businesses match up. The danger, of course, is that those future growth expectations overshoot. There’s too much hope, too much expectation, and in those instances, elevated share prices will then take the strain, and it’ll particularly harm investors who have been very late to the technology party and have only been buying in recently.

That being said, and as you’ve outlined, Richard, the so-called Magnificent Seven stocks, and indeed other AI-related businesses, could well deliver against the elevated level of earnings expectations.

Polar Capital Technology Ord (LSE:PCT) trust is one of the main ways for retail investors to gain exposure to a collection of different technology businesses. That investment trust invests in a number of technology trends. One of those is AI.

Its longstanding fund manager, Ben Rogoff, gave three reasons recently explaining the differences between today and the dotcom bubble. He said that 'While valuations are extended, we do not believe they are extreme or at bubble levels today. The technology sector is trading at around 30 times on the forward earnings per share (EPS) ratio, and this compares to 50 times EPS ratio during the dotcom bubble.’

Another point he made is this while AI investment is large and it’s growing quickly, it’s far from the bubble level compared to its historical technology build-outs.

The third point he made, which you alluded to earlier, Richard, is that the source of capital is very different today compared to the dotcom bubble, as most AI capex (capital expenditure) has, so far, been funded through balance sheets and cash flows of the world’s biggest companies.

He points out that while leverage is picking up, only 7% of AI capex has been financed with debt.

But, of course, Richard, time will tell, and I’m sure I’ll have you back on the podcast around this time next year to discuss what’s happened and whether your investment predictions and themes came to pass.

Richard Hunter: Very much look forward to it, Kyle. Here’s to 2026.

Kyle Caldwell: Richard, thank you for your time.

Richard Hunter: Pleasure.

Kyle Caldwell: Thank you for listening to this episode of On the Money. This is the last episode of 2025. We’ll be returning on 8 January 2026, and I’d like to wish all our listeners a great festive period.

In the meantime, you can find more information and practical pointers on the interactive investor website, which is ii.co.uk, and I’ll see you in 2026.