Stockwatch: what I think could go right and wrong in 2026
After another eventful year where stock markets extended their winning run, analyst Edmond Jackson discusses the outlook for the year ahead and which way share prices might go.
31st December 2025 08:38
by Edmond Jackson from interactive investor
Respecting Ray Dalio’s adage: “He who lives by the crystal ball will eat shattered glass”, I style my 2026 outlook in terms of scenarios.
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What could go right?
There is enough US economic momentum
Economists unanimously predicted a downturn in response to President Donald Trump’s watered-downtariffs being akin to the 1930 Smoot-Hawley Tariff Act that preceded the Great Depression. Yet the US economy has maintained its habit of surprising on the upside.
Boosted by higher consumer spending and exports, annualised growth was 4.3% in the third quarter of 2025 versus 3.8% in the second, marking the strongest rate in two years. Consensus had been for 3.2%.
Consumer spending – around 70% of US economic activity – rose by an annualised rate of 3.5% versus 2.5% in the second quarter, driven by healthcare services spending. Next spring is set to be the largest tax refund season ever, under terms of the One Big Beautiful Bill passed last July.
Meanwhile, imports have continued to decline due to tariffs, but exports leapt by 7.4%. Government defence spending also rose.
US corporate earnings have held up very well. In the third quarter, over 81% of companies beat earnings expectations led by IT, consumer staples and the financial sector. This implies market breadth and includes banks, possibly an indicator of firm economic prospects. It is also well above the historic average, and is the second-best since the last quarter of 2021. Both revenues and margins contributed.
Artificial intelligence (AI) spending shows little sign of being compromised by tariffs, although overall business spending has slowed and the housing market been somewhat crimped by relatively high interest rates. For equity investors, however, this has usefully led to three interest rate cuts from September to an effective federal funds rate around 3.6%, reinforcing a “buy any drop” mantra.
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Sceptics can say this was all before the longest-ever government shutdown from 1 October lasting 43 days, yet the aspect of momentum is noteworthy.
In the UK, the third quarter was quite similarly one of company results broadly in line or ahead of expectations, with only selective profit warnings. Stable credit quality and healthy margins also helped banks, where you might anticipate more signs of stress if a downturn is due. Retailers such as Sainsbury (J) (LSE:SBRY) and Marks & Spencer Group (LSE:MKS) surprised on the upside due to cost controls and stable grocery sales. But discretionary spending is generally pressured.
Yes, insolvency specialist Begbies Traynor Group (LSE:BEG) was able to cite 7% interim revenue growth and “encouraging workflows” from 1 November, although it is exposed to smaller private companies where administrations from excess debt can be seen as good for the economy.
From a company analyst perspective, the overall mood music emanating from results and updates is not close to indicating a recession.
Major global conflict areas may remain contained
The Gaza ceasefire has lasted over two months following two years of fighting between Israel and Hamas. On the face of it, a truce seems unlikely to hold given that Hamas must disarm under the Trump plan, but the group will only do so once there is a Palestinian state, which Israel objects to. The extent of division implies an essential state of conflict to drag on.
In fairness to Trump, he has wrested the two sides apart for a decent while. It might not win a Nobel Peace prize, but mitigating risk of a Middle East eruption is a major plus for investors.
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Meanwhile, a “war of attrition” - as criticised by the Trump administration – drags on over Ukraine, a latest £79 billion equivalent loan from the EU earmarked to assist its defence until late 2027. A similar stalemate here seems an economic liability, although it’s unclear whether such debt would ever get re-paid back. Politicians would argue that appeasing Russia raises greater risk.
Ukraine has thus retreated to the edge of investors’ radar, quite like Gaza, being no longer seen as a potential flare-up despite gold continuing to rise as a supposed proxy for risk. Oil prices, a usual worry when Middle East conflict is involved, have reached five-year lows around $60 for Brent crude amid raised output from non-OPEC countries and subdued demand, especially from China.
Share buybacks may continue to offer technical support
Expectations for the US are in the order of $1.2 trillion (£890 billion) in share buybacks relative to a record $1 trillion in 2022 and an estimated $68 trillion value for the US market as a whole.
By comparison, the UK has historically favoured dividends, although buybacks increased after Covid when company boards judged shares to be undervalued amid a wave of takeovers.
On a daily basis, one has to wade through a torrent of “Transaction in Own Shares” RNS company announcements to find those that actually relate to company performance. It is hard not to see this as contributing to the rise in equity markets.
What could go wrong?
Tariffs and taxes finally bear down on US/UK consumers
This may be a case of delayed impact.
The US personal consumption expenditures price index – the Federal Reserve’s preferred inflation indicator – rose a more marked 2.8% in the third quarter versus 2.1% in the second. Meanwhile, a near 17% fall in consumer credit later this year hinted at tighter household budgets.
In the UK, higher taxes since November’s Budget may further discourage business investment and consumer spending, although wage rises appear so far to have limited the impact on discretionary spending.
A dilemma for US consumer spending is Trump’s tax cuts favouring the richest 1%, while middle-to-low-income households have seen minimal or rising tax burdens as provisions expire and social programmes are cut.
If overall consumer spending slows, it would also affect export-driven economies such as Asia Pacific.
Trade policy could therefore be said to remain the biggest challenge for 2026 as higher prices work through the economy and tariffs disrupt supply chains.
A potential inflection point downward for US stocks?
Global equity valuations are median and in the 13-21x range seen around Covid and, setting aside the US, are on a forward price/earnings (PE) ratio around 15x.
By comparison at near 29x trailing earnings, the S&P 500 PE is well above its five-year average of 20x and 10-year average of 18.7x. This falls to around 23.5x on an estimated future earnings basis, yet the cyclically adjusted price/earnings, or CAPE ratio is above 40x versus 30x in 1929 prior to the Wall Street Crash and the 1999-2000 tech bubble.
CAPE divides the share price or index by the average of the past 10 years’ inflation-adjusted earnings. Its potential flaw is underestimating times of seismic change, although that was an apology for what proved to be over-hyped dotcom shares in early 2000.
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AI does offer greater efficiency, and leaders such as NVIDIA Corp (NASDAQ:NVDA) have delivered strong earnings. However, more widely, US tech valuations remain highly speculative.
Yet any break in overvaluations would appear to need a disruption to the story; chiefly, that all the money being spent on AI may not achieve desired efficiencies and gains. Valuations could start to fall anyway if stale bulls fail to keep buying.
As for the Magnificent Seven tech stocks, they constitute around one-third of the S&P 500’s valuation. “Mind the valuation gap” - US equities are nearly 65% of the global valuation versus US GDP being less than 15% of the global total in 2024.
UK shares are ‘cheap’ relative to the US
The average PE of UK stocks has soared from 9x in October 2022 post the Covid low and is now in the high teens. That’s a growth-type PE seemingly at odds with a socialist government in tax-raising mode.
Time will tell whether higher benefits and public sector pay – the chief recipients of tax rises – prove beneficial for sustaining aggregate demand, or whether this comes at the expense of younger talented people seeking careers abroad.
Perhaps this helps explain why takeovers have slowed, hence we can no longer expect underperforming “cheap” shares to be rescued.
It all depends how updates and earnings guidance pan out, hence why it’s eyes-down on new year updates. Footfall was supposedly down in high street shops on Boxing Day, although I was told people were going “bonkers shopping” in Knightsbridge, so maybe “luxury” outperforms. We’ll see. Retail parks also saw a 7% like-for-like rise in footfall.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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