Will the global stock market continue to party in 2026? Be aware of these "undercurrents"

By 2025, global stock markets are performing strongly, and this optimistic trend is leading investors into 2026 with a bullish sentiment. Currently, stock allocations are continuing to rise, and the cash holdings of fund managers are at historically low levels. Investors' expectations for further market rises outweigh concerns about stocks being overvalued, significant capital expenditures in the field of artificial intelligence (AI), and overly optimistic profit expectations. However, beneath the surface, the optimistic sentiment about the economy is facing challenges, especially considering the recent weakness in the US labor market. The outlook for interest rates is likely to once again become a focus of concern for investors, as the market has only priced in expectations for two rate cuts by the Federal Reserve next year. "As we enter 2026, global growth may remain stable, but uncertainties are increasing," said Seema Shah, Chief Global Strategist at Principal Asset Management. "Although the US economy continues to benefit from AI-driven investments, a robust consumer balance sheet, and targeted fiscal support, structural risks are on the rise. Inflation is showing stickiness, labor market dynamics are changing, and the Fed is facing a serious test of policy balance." High valuation levels Driven by the technology sector, the forward valuation ratios of the S&P 500 index have reached historic highs. This indicator has not only surpassed previous key highs but historically, these highs have often been harbingers of significant corrections - such as the summer before the bursting of the dot-com bubble in 2000, and the point in January 2022 when market pricing rates began to rise sharply. "The current bull market is now in its fourth year, and market volatility may become the norm. Against a backdrop of high growth expectations, volatility could further intensify," pointed out Scott Chronert, Chief Strategist at CitiGroup, and his team. "It needs to be clear that high valuation starting points are indeed a major obstacle to market uptrends, but not insurmountable. However, this will put greater pressure on fundamental factors of companies, requiring ongoing support of fundamentals to sustain current stock prices." With soaring valuations, discussions about "bubbles" in the market are intensifying, with the technology sector and AI concept stocks becoming the focus of such concerns. Top cloud service providers are continuing to increase capital expenditures, with their scale nearing the limits of their balance sheets' capacity. While this issue has not yet spread to the entire market, the "supervisors" of the bond market are poised for action. A recent underperformance by Oracle Corporation (ORCL.US) resulted in a sharp drop in stock price, with its credit default swap price simultaneously skyrocketing to historic highs, serving as a direct example. Pressure to meet profit expectations For companies to maintain positive market sentiment, they must deliver on profit commitments - and this time, the threshold set by the market has significantly increased. The market generally expects double-digit earnings growth for major companies in various global regions, with emerging markets being highly anticipated as the core engine of growth. However, this expectation may be overly optimistic. Asian regions need to achieve their established economic growth targets, Europe's fiscal stimulus policies need to actual profits for companies, and the growth prospects of the United States rely entirely on the continued advancement of the AI revolution and the resilience of the labor market. Continuation of sector rotation Over the past two months, with AI and semiconductor sectors undergoing adjustments, more attractive investment opportunities have emerged in other areas, leading investors to embark on a process of rebalancing their portfolios. This sector rotation phenomenon is synchronously playing out in European and American markets, with regional differences in specific rotation paths. Sector rotation helps broaden the foundation of market upturns, channeling funds into cyclical sectors, defensive assets, and sectors that have previously lagged. Given the ongoing questioning of investment returns and business models in the AI sector, investors in 2026 are likely to continue this rotation of holdings based on themes. Over the next two to three earnings seasons, as investors gradually understand the fundamental conditions of each industry, the switching of funds between sectors may further intensify. Seasonal effects of the new year At the beginning of each year, the seasonal rise in market risk appetite typically provides upward momentum for stocks. The resetting of the new year's risk budget, the transition of performance evaluation cycles, and the regular injection of pension funds are typical factors that drive market strength. Historically, from the first quarter to April, the stock market has generally performed well in 2026, but January and February are not traditionally "big rise windows." Recent data also confirms this pattern, with both market gains and losses occurring during these two months. Golden window for stock picking In 2025, due to the overweighting of large-cap tech stocks in major indices, market returns exhibited a high degree of concentration, while correlations between index constituents fell to low levels, creating an excellent operating environment for stock-picking investors. Although the market landscape may change in 2026, with the expansion of rising sectors and the turnover of industry leaders, actively managed fund managers are likely to outperform their benchmark indices. The team led by Jean Boivin, Chief Investment Strategist at BlackRock, Inc., said, "We still maintain a risk-on stance and believe that the AI theme remains the core engine driving US stock performance. However, in the current environment, active investing is entering a golden period - we judge that as AI dividends gradually spread, selecting benefiting targets within the industry chain, and avoiding potential risks, individual stocks will be the key to victory, whether now or in the future." Crowded holding structures Lastly, it is important to be vigilant as the current market holdings are relatively crowded. A survey of fund managers by Bank of America Corp shows that investors are generally optimistic about 2026, with high expectations for economic growth, stocks, commodities, and various asset classes. The total exposure to stocks and commodities, typically assets that perform well during economic growth, has reached its highest levels since February 2022. At the same time, cash levels have plummeted to just 3.3% of managed assets, hitting a historic low. The team at Goldman Sachs Group, Inc., led by Kamakshya Trivedi, pointed out, "The greatest downside risk in the current market is still the extent to which the US labor market deteriorates beyond expectations, leading to a resurgence of recession risks." The Goldman Sachs Group, Inc. team believes that the market is currently pricing in recession risks too low, and the biggest micro-level threat to US stocks is the substantial challenge to the AI investment theme. Based on this, they recommend that investors broaden the geographic and sector coverage of their stock allocations, increase positions in some traditional cyclical sectors, as well as undervalued defensive sectors like healthcare.