Executive Summary: The “Easy Money” Phase is Over

I wanted to send out this executive summary of my 2026 outlook before year end. Full document will hit your inboxes in the next week or two.

The thesis I presented for 2025 regarding Emerging Markets has played out with precision. My high-conviction call on Alibaba (BABA) and the broader EM basket has delivered returns approaching 80%, significantly outpacing the S&P 500’s respectable, yet trailing, performance.

As we look toward 2026, the narrative changes. The last three years have provided a structural tailwind that made “buying the dip” a nearly flawless strategy for retail investors. I believe 2026 will be a much harder year. The market is transitioning from a beta-driven rally to an alpha-driven environment. This year will test discipline; for many retail traders, the profits of the last 36 months may prove to be merely a “temporary loan” from the market.

However, the macro backdrop remains constructive. We are entering a year defined by the USA’s 250th Anniversary, the World Cup, and an administration focused on deregulation. The Federal Reserve is cutting rates, Quantitative Tightening (QT) has effectively ceased, and liquidity is being injected via T-Bill purchases, a mechanism that looks, waddles, and quacks like QE, even if the Fed refuses to label it as such.

My S&P 500 Year-End Target for 2026 is 7,400, with a bull case of 7,700. But the path there will be volatile.

Key Takeaways

The “Great Hand-Off” in Earnings: For the first time in a decade, the “Remaining 493” stocks are projected to contribute more to S&P 500 earnings growth than the “Mag 7” (7pp vs. 6pp).

AI Phase 2: Outperformance shifts from the builders (Hyperscalers with massive Capex) to the adopters (companies using AI to increase profit per employee).

Mid-Term Seasonality: 2026 is a Mid-Term Election year, historically the weakest of the four-year presidential cycle. Expect 1H volatility.

The Fed Pivot Risk: A friendly Fed supports Small Caps and Emerging Markets. Kevin Hassett is the ideal pick for Chair to sustain this; a Kevin Warsh appointment introduces hawkish risk that could derail the soft/no landing.

Sector Rotation: I am overweight Healthcare, Energy, and Emerging Markets. I am cautious on Hyperscalers due to FCF erosion.

The Core Narrative

The Earnings Inflection: The “493” Take the Baton: The most compelling data point in our 2026 deck is the structural inflection in earnings contribution. Since 2023, the market has been carried by the Magnificent Seven. In 2023, the Mag 7 contributed 3 percentage points (pp) to growth while the rest of the market dragged it down by 3pp.

That era is ending.

Looking at our 2026 EPS projections, the “Remaining 493” are set to contribute 7pp to earnings growth, eclipsing the Mag 7’s 6pp. This is not a bearish signal for the market, but it is a bearish signal for concentrated tech exposure. The breadth is finally widening, driven by a cyclical recovery in earnings rather than multiple expansion.

The AI Capex Conundrum: Bubbles Form in Cash Flow, Not Price: While bears scream about P/E ratios, the real risk in Big Tech is Capital Intensity. The Mag 7 are currently borrowing more capital in the current quarter than in any full year in history (excluding 2017).

FCF Erosion: As I’ll show in my Hyperscaler analysis, AI infrastructure spending is skyrocketing. This massive Capex spend (forecasted to hit nearly $300bn combined by 2026 and 500bn by 2029) is dramatically eroding Free Cash Flow (FCF).

The Valuation Trap: While Mag 7 P/E multiples have compressed due to strong earnings, their FCF yields are deteriorating. If the AI revenue monetization does not arrive immediately to offset these costs, we risk a “bubble” atmosphere, not of stock prices initially, but of unsustainable capital deployment.

For 2026, I do not expect Tech to lead. The question I pose is, “What comes first, the 10 largest weights going to 50% of the index or reverting to 30%?” I lean heavily toward 30%.

Macro Tailwinds: The “Not-QE” Liquidity Pump

The Fed has announced the purchase of billions in short-dated government bonds to manage liquidity. While the headlines read “Just Don’t Call It QE,” the market mechanics are identical: the Fed is providing liquidity injection.

Combined with a weakening US Dollar, this creates a “Goldilocks” scenario for Emerging Markets and Small Caps.

Emerging Markets: My EM basket (highlighted by the 31.6% return in 2025 vs US 168%) continues to benefit from a falling dollar. I, of course. favor China.

Small Caps (Russell 2000): These companies are most sensitive to floating rate debt. As rates fall and the administration cuts regulations, the Russell 2000 is poised for a continued breakout.

The Personnel Risk: The trajectory of this liquidity depends on the next Fed Chair.

Bull Case: President Trump appoints Kevin Hassett. Hassett understands the need for accommodation to support the “lowest interest rates” mandate.

Bear Case: The appointment of Kevin Warsh. While he looks the part, Warsh carries a hawkish bias similar to Powell. His appointment would likely spike the TNX (10-Year Yield) above 5%, causing immediate multiple compression in equities.

Sector Selection: “So Bad, It’s Good”

Valuation spreads are at historic extremes. (From Tom Lee) Z-Score analysis of 3-year returns relative to the S&P 500 identifies deep value in cyclical sectors:

Healthcare: Currently at a Z-Score of -4.05 (Cyclical Low). Healthcare historically outperforms during Mid-Term election years as a defensive safety valve.

Basic Materials & Energy: Both are sitting at cyclical lows (-4.02 and -1.35 Z-scores respectively). As the global economy re-accelerates (aided by Chinese stimulus), commodities are the logical hedge against inflation.

Financials: With a steeper yield curve and deregulation, financials offer asymmetric upside.

Risks & Seasonality: The 2026 Chop

We must manage expectations. Mid-Term Election years (like 2026) are notoriously difficult.

Seasonality: Historically, mid-term years show sub-par performance (avg 2.2% gain) compared to pre-election years (12.1%).

Sentiment: Fund Manager Cash levels have dropped to a low of 3.3%. When “smart money” is fully invested and retail flows are chasing highs, the market is vulnerable to a washout.

The 1H Correction: Technical indicators (DeMark exhaustion signals) and Elliott Wave counts suggest a high probability of a 10-15% correction in the first half of 2026. This will be the moment retail traders panic and “give back” their loans.

Conclusion: Stay the Course, But Rotate

Despite the anticipated volatility, I remain constructive on the destination. My sensitivity table suggests that if 2027 EPS hits $350, a 22x multiple gets us to 7,700.

However, the vehicle for these returns has changed. The “Mag 7” trade is tired and capital-intensive. The “Remaining 493,” Emerging Markets, and Small Caps are fresh and efficient.

Guidance:

1. Do not try to time the exit. Missing the “10 Best Days” since 2016 would have turned a +14% return into a -9% loss.

2. Rotate into Value/Cyclicals. Overweight Healthcare, EM, and Energy.

3. Be opportunistic on dips within great companies and even Hyperscalers.

4. Watch the Fed pick. Hassett is the green light; Warsh is the caution flag.

5. Buy the “Users.” Rotate into Industrials and Financials that are implementing AI for efficiency

6. The easiest way to beat the market in 2026 is wait for a 12% correction and start buying. Buy every 2-3% drop after the 12% drop down to 20-25%.

7. Overweight real assets like commodities, materials, and energy.

2026 will not be a straight line up. It will be a year where stock selection, rather than index exposure, determines who keeps their profits and who returns the loan.