Market Update: Start with a bang

However, as the year drew to a close, growth in both the US and UK softened enough to cool domestic inflation. That should mean more interest rate cuts, which would help businesses and equity valuations.

The softer US economy has prompted Trump to promise more spending, despite an AI-related spending spree forthcoming. The administration has ordered government-sponsored housing institutions to use their balance sheets to buy $200bn of existing mortgage bonds. This should force down mortgage rates, similar to the Fed’s quantitative easing. The prospect of stronger growth is helping markets, despite concerns over Trump’s disruptive policies and market interference.

Markets’ current nonchalance does not mean Washington’s agenda will work in the long-run. Former IMF economist Gita Gopinath wrote in the Financial Times this week that the impacts of US trade disruptions have so far been obscured by European and Chinese fiscal stimulus, and the AI boom. Just like after the Brexit referendum, short-term profits have not taken a hit, but over the long-term, the detrimental impacts on growth are clear.

The big AI spend is coming

Many worry that AI is papering over the cracks in the US economy: big tech is seeing corporate earnings growth while the rest struggle. That might be a fair description of US growth last year, but not of the current capital investment drive – in which billions are being spent to build and service vast new datacentres. Firms raised huge amounts of capital last year, and are now spending it quickly on the more traditional parts of the US economy. The current AI capex surge is not so much papering over the cracks as filling them with cash, and fast.

The idea is that the capital stored up in big tech (on their balance sheets or in their share prices) might be used to build things, which means better profits for the previously unloved parts of the economy. Investors could therefore rotate out of the big winners into the previous losers. At the end of November, JP Morgan Research gave the following view:

“The AI sector’s momentum is spreading geographically and across a diverse list of industries, from Technology and Utilities to Banks, Health Care, and Logistics, and in the process creating winners and losers. AI contributed roughly one-third of global growth in the 1H25 and our global equity strategists see earnings accelerating above trend to 13-15% over the next two years, driven by AI secular tailwinds. This compares to the long-term average EPS growth of 8-9%”

We have seen exactly that in recent weeks. In the US, previously ignored companies have been winners: value is easily outstripping growth; small cap, mid cap and value stocks have pushed ahead. We have had false dawns before and it is far too early to call this a trend, but it is certainly something to keep an eye on.

Even if rotation becomes a trend, it does not mean US tech will do badly. Most of the companies are far too profitable to have any serious problems. A better way to put it is that, in the medium-term, actual earnings growth will support tech shares but it is hard to see future growth expectations pushing up share price valuation multiples (relative to earnings) much further. In other words, gains for the megacaps will likely have to come from maintained outperformance in profit growth.

Will growth be too much of a good thing?

The decent outlook for global growth should support markets, but it might not mean another massive equity rally. Money being spent to build infrastructure is money not stored in asset markets. Stock markets already seem to have priced in strong global growth for 2026, so we might just see the economy catching up to where asset prices already are. Markets rarely fall when growth is strong but they might not be pumped up to the same extent they have been.

If economic growth is to translate into equity market performance,  it is important that global inflation remains benign. With increased capital spending, a boost from lower rates and disruptive trade policy, the danger is that inflation could reaccelerate.

Inflation will likely remain subdued as long as employment markets remain relatively weak – as they have been across the developed world. We have noted for a while US companies have not been hiring (though they are not firing either) for example, which seems to be AI-related. At some point, though, the massive infrastructure buildout will surely mean more employment. At that point, inflation could return, central banks could tighten up and investors would reassess the outlook. That is a risk for the second half of 2026 that we will have to watch.