This week, I want to discuss three topics: the economy and its impact on the stock market for 2026, affordability, the word that has emerged as a leading focus within our political lexicon, and the Fed which meets this week to discuss the future course of short-term interest rates.
I will tackle each in reverse order.
For much of the past several decades, the Fed has been largely unified behind its leadership. Yes, there were dissenting votes at various FOMC meetings but it was clear to most that leaders like Paul Volcker, Alan Greenspan and Ben Bernanke had enough influence that a clear path forward, for better or worse, could be well defined to the public. That doesn’t mean every decision was right. But it did mean that market observers would have a pretty well-defined path of future expectations. But today is different. It would be easy to say it’s politics, attempts by the Trump White House to brow beat the FOMC committee to do what it desires. But that’s a false narrative. Yes, Trump would like to see rates lower than they are today. But that is almost always the desire of every President. Lower rates are stimulative and no leader wants a slower economy going forward. Rather, the confusion today comes from within. Chairman Jerome Powell is a lame duck. This Fed more than most has been extremely backwards looking. Powell has always sought to be a consensus builder rather than a leader who defines policy himself. The result lately has been one that lacks unity and amplifies confusion. Although markets remain stable with 10-year Treasuries still anchored in a 4.0-4.5% range, the path forward remains opaque. Opaque is rarely a positive.
What markets want from the Fed are the following:
• Remain independent – This is paramount and comes to the fore every time President Trump tries to exert too much influence on the Board. The Supreme Court will hear cases that relate to agency independence this term. It has previously signaled that the Fed may be exempted from whatever ruling it delivers next June. Hopefully, that will hold true. If not, markets will have a hissy fit. The Court knows that. Expect whatever decision is reached, the Courts will allow the Fed to remain independent within defined boundaries.
• Develop and enunciate a forward-looking game plan that businesses and investors can understand – Is there a neutral rate targeted via Fed policy? Is the Fed expected to tolerate inflation beyond 2% for some time in order to stimulate labor growth? Might the Fed allow greater inflation to deflate the real value of our burgeoning national debt? That could be a tactic although voters don’t seem in the mood to tolerate higher than normal inflation.
• Unity – Each FOMC member has his or her own vote. But the Chair ultimately defines direction. Volcker’s focus was defeating inflation. Greenspan wanted to stimulate growth to the max. Bernanke had to heal wounds of a financial crisis. Liquidity was a dominant concern. Times today are less turbulent. Yet markets like strong leadership from a respected leader. Market acceptance of Trump’s appointee to replace Powell will be critical.
Virtually everyone today agrees the Fed needs reform. That will be a key task of the new Fed Chairman. But before reforms can proceed, the new Chairman has to bring unity and define focus. It will be a tough task and markets will be watching.
The Fed’s major focus over the years has been on containing inflation. The Fed alone can’t control the future pace of inflation, but it can via interest rate policy exert pressures on supply and demand to strongly influence the pace. Obviously, with hindsight, the Fed did not see the extent that a combination of very low interest rates and pandemic-induced supply chain disruptions would have, first labeling signs of inflation as transient before acting in a heavy-handed way to regain control. The result was a cumulative rise in prices that Americans found painful. It’s important to note that inflation data represents the pace that prices are rising today. The monthly data focuses on month-over-month or year-over-year data. It pays little or no attention to 5- or 10-year changes. But if you bought a car 5 years ago and now are ready to trade that it for a new car, you will note prices that are 27-30% higher, an annualized inflation rate of about 5%. That doesn’t take into consideration insurance costs that have risen even faster in the interim. The same dynamic applies to housing.
Home prices, rents, car payments, and even the costs at the supermarket show the cumulative impact of inflation over the last five years. Consumers increasingly are having a tough time making ends meet. That raises the affordability issue. Consumers have proven both resilient and adaptive. But that doesn’t mean they are happy. They trade down buying a used car instead of a new one or renting a smaller apartment than previously desired. Look at recent elections as an exclamation point. The Trump administration has gotten the message loud and clear. The question is what can it do about it? Forcing some drug prices down, or pulling back from tariffs on products we can’t produce in the U.S. may help around the edges, but collectively they are not a solution. Solutions are longer term, for example, public-private partnerships to create more housing units. A sensible tariff policy that is more focused. No need for tariffs on coffee and cocoa or, for that matter, electronics built into cars not available from U.S. suppliers. Affordability is the key focus issue today in every Congressional district.
2025 has been a tumultuous year. Tariffs. DOGE. The huge tax bill. A surge in AI capital spending. A resilient consumer still employed and still spending while pinching pennies (which are no longer being minted!). Yet, excluding the impact of varying trade deficits and inventory management, the economy keeps growing. While labor markets suggest finding a new job is a challenge, there have been few layoffs. Productivity is improving and corporate profit margins continue to rise.
In the end, stock prices are all about earnings, interest rates and inflation expectations. Earnings are rising, inflation expectations seem well anchored in the 2.25-2.50% range, and the 10-year Treasury is well anchored. There are concerns to be sure. Valuations are high but so are free cash flow returns and returns on equity. Low interest rates support higher than normal P/Es. Over the past 50 years, the only pure valuation correction was in 1987 and that was a year when stocks and bonds went in opposite directions for over six months, not the case today. If one looks at the equal weighted S&P 500, gains to date this year are less than 10%, certainly within a normal range. To be sure it has been a bifurcated market with many stocks up 20% or more but almost a third of the S&P 500 are down year-to-date. It’s been a bifurcated economy as well.
Thus, recognizing the disparities in the economy and in markets, there is no reason to expect much to change in a macro sense. But looking ahead, what worked in markets and the economy in 2025 may not be the same next year. Next year, perhaps, we will be better able to separate AI winners from pretenders. We will get a better picture of capex needs to support the AI revolution. Early expectations are rarely accurate. As for what we might call the core economy, fewer tariff increases, large tax refunds, and a pro-business policy in Washington should support another growth year. It’s hard to be negative on markets unless on expects lower earnings, rising inflation or higher interest rates. We don’t see that. Staying true your long-term asset allocation continues to make sense.
Today, Larry Bird is 69. Johnny Bench turns 78. Finally, Ellen Burstyn, who won Academy, Emmy and Tony awards putting her in rare company, celebrates her 93rd birthday. A life well lived.
James M. Meyer, CFA 610-260-2220