The S&P 500 fell 1.6% last week, and volatility ramped up over fears that AI stocks are in a bubble and valuations overall are stretched. The good news is we continue to think earnings are justifying this bull market. But pockets of technology could be a tad frothy, and a pause and a bit of consolidation is perfectly normal and even healthy. This is why we preach to stay diversified, as other pockets of the market are doing just fine.
The Price We Pay to Invest
This week is a good time to dust off one of our favorite charts and themes. It turns out all years have bad news and some bad days, with 2025 certainly not the first year to buck this trend.
Think about just the past two years, as stocks gained more than 20% each year, yet there were some real freakout moments for investors. In 2023, March saw the regional bank crisis, and there was legitimate (but very exaggerated) fear that the entire system was going to collapse because of what was happening at just a few regional banks.
Sounds silly now, but if you were there, then you know exactly what we’re talking about. Then 2024 saw more spectacular gains, but for a few days in early August, many investors suddenly became panicked about the ‘yen carry trade unwind.’ We won’t get into all of that, but know that Japan’s Nikkei had its worst day since the 1987 crash and global markets were melting down. Then a few days later it was over, and we were off to the races again.
You can do yourself a big favor if you go into each year expecting to see some scary headlines and big down days.
We like to say that volatility is the toll we pay to invest. To benefit from longer-term gains, you may need to deal with some short-term pain. This is one you should print off and put on your desk as a reminder when those scary days happen.
The Slingshot Is Real
Lastly, this year is shaping up to be quite historic. It may turn out to be one of the few years that was down 15% at some point during the year yet closed up double digits. Yes, the year isn’t over yet. But should this year remain strong (as we expect), it will join 1982, 2009, and 2020 as the only other years to achieve this incredible feat.
Down periods like we saw earlier this year can act like a slingshot—stretching it in one direction can build up energy for strong momentum in the other direction once you let the slingshot go. And it’s not just the immediate rebound. The next calendar year also tends to do well, too (2026, in this case). All three prior instances of going from 15% down to a double-digit gain in the same year also saw at least a double-digit gain the following year with a very impressive average gain of 19.0%. File this one under reasons to be bullish as we head into 2026.
5 Market Commandments
This week and next week, we’re going to take a look at some important tailwinds we see from markets for the end of the year into 2026, and in some cases even across 2026 and beyond. We can summarize these with some of our “commandments” of investing, although think of them more as good advice that deserves our attention.
Here they are…
- Don’t fight potential global recovery (and companies’ ability to benefit from that).
- Don’t fight loose fiscal policy (and there may be more to come in an election year).
- Don’t fight the White House (and its desire to boost markets).
- Don’t fight the Fed (and their prioritizing boosting the labor market).
- Don’t fight momentum and seasonality.
Today we’ll focus on policy (as it relates to markets). There are three to watch: fiscal policy, trade policy, and monetary policy from the Fed.
Don’t Fight Loose Fiscal Policy: Tax Cuts
Did you know that Congress passed a massive deficit-financed tax bill this summer? The One Big Beautiful Bill (OBBB) hasn’t gotten much news since it passed, but it’s going to increase deficits by about $4 trillion over the next decade, including interest costs (the cost will rise to $5.5 trillion if tax cuts are extended beyond 2028, which is likely). That means the deficit is going to run at a whopping 6–8% of GDP for a few more years. The US government has never run this level of deficits (as a percent of GDP) in the middle of an economic expansion. Historically, the budget balance heads towards a surplus as expansions continue, but not now. That’s not great for the government’s balance sheet (more than half the deficit is interest costs), BUT the other side is that deficits flow into corporate profits. That’s good for markets in the near term, especially since a lot of the tax cuts were front loaded. Tariff revenue will offset some of this but not all (assuming that the tariffs even stick around).
An immediate positive impact of the tax bill, for the economy and even markets, is that a lot of tax cuts were made retroactive to 2025. This includes new deductions on tips and seniors’ income, and much larger deductions for state and local taxes (income and property taxes). That means a lot of households are going to see out-sized tax refunds in the first half of 2026, which is likely to boost consumption (and markets, if households use some of the money to buy stocks).
The risk here is obvious. Households spending all that money could boost inflation further from already elevated levels, which creates a problem for the Fed. And deficits could cause problems down the road. But the bottom line is in the near term, markets like fiscal stimulus, and from a macroeconomic perspective, they should.
Don’t Fight the White House: The End of Tariff Chaos
We’ve been in the camp since at least July that the trade war was behind us (though the market seemed to think that was the case all the way back in May). The current level of tariffs is around 11 percentage points higher than where they were at the start of the year, but with all the workarounds and exemptions (especially for items crucial to the AI build-up), tariffs are in a much better spot than the worst case expected amidst Liberation Day. Many companies have obviously figured out how to deal with the tariff environment as well, which is why earnings growth is strong. Moreover, the latest “deal” with the Chinese puts the trade war further in the rear-view mirror. That in and of itself means there’s a lot less uncertainty in 2026 (at least until the fall of 2026 when the terms of the deal with China have to be re-upped).
The president has also floated a few trial balloons of sending “tariff refunds” back to households. While the president will need Congress to sign off on this, it speaks to intent—the White House is very tuned in to markets, and the administration is likely to try and mitigate as much volatility as possible, especially in an election year.
This could even be helped by the Supreme Court ruling against a chunk of the administration’s tariffs imposed under IEEPA (International Emergency Economic Powers Act). The obvious positive there is that companies could request refunds, bolstering their balance sheets/cash-flow in 2026. However, the administration is likely to use other tariff powers to re-impose the tariffs, especially on large trading partners. But that’s going to take time. It does mean, however, that the cloud of tariffs, and associated uncertainty, could hang over companies next year as well, but it would be from a better starting point than we were at this year.
Don’t Fight the Fed: Interest Rate Cuts
There’s some uncertainty around a rate cut in December, with Powell refusing to commit to a cut after the Fed’s October meeting. The Fed’s caught between the two sides of their mandate—stable inflation and maximum employment. Inflation is running around 3% currently, well above the Fed’s target of 2% (that’s been true for four and half years now). On the other hand, there’s an elevated risk on the labor market side, with weak hiring. In the Fed’s view, the risks to both sides of their mandate are equal, and in that event policy rates ought to be “neutral” (neither too loose nor too accommodative), which according to Fed forecasts means around 3%. Policy rates are just shy of 4% presently, which means we’re likely to see more rate cuts that take rates closer to that 3% level over the course of 2026, even if we skip December. And if not by a Powell-led Fed, then under a new chair appointed by President Trump next year (and one likely to be much more amenable to rate cuts). That’s why markets are pricing in a dovish Fed over the next year or two, followed by gradual tightening after 2028 as the Fed refocuses on inflation.
A dovish Fed that is cutting in the face of elevated inflation is yet another near-term tailwind for markets. The Fed has already cut 0.5 percentage points in 2025, on top of 1 percentage point in 2024. The cumulative 1.5 percentage points of cuts is now the largest mid-cycle adjustment since the mid-1980s. The impact of recent cuts will likely flow through into the economy in 2026, with cyclical, rate-sensitive areas of the economy benefiting.
The risk here is that the Fed pulls back from the expected rate cut trajectory, perhaps because the labor market picks up steam again (which would not be a bad thing for the economy) or that inflation shows no sign of abating and rises even further amid tax-cut fueled spending in 2026 (which would be more worrying).
Policy Currently Market Positive
Independent of the party in power, if someone told you that we’re sitting in the middle of an expansion but the Fed was cutting, Congress was providing historic levels of deficit-financed stimulus, and there were strong signs that the White House will be increasingly sensitive to markets with mid-term elections less than a year away, what would the takeaway be? Every period has its own risks and challenges, but the starting point would be a bullish bias. And remember, that’s just policy—there’s more. Next week we’ll look at support from the international economy and market momentum and seasonality.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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