Reversal of fortunes? Reversal of fortunes? http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\landscape-thailand-small.jpg December 22 2025 January 2 2026

Reversal of fortunes?

Federated Hermes 2026 outlook series.
Published January 2 2026
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Bottom Line  

Equity investors have been spoiled the past three years. The S&P 500 erased 2022’s brutal 18.2% decline with positive double-digit total returns in each: 26.3% in 2023, 24.8% in 2024 and 17.9% in 2025. It amounts to the S&P’s seventh-best three-year run on record.

Is past prologue? As we look across the proverbial valley into 2026, some investors are concerned that the midterm election year could result in a correction. These worries have been particularly acute about the stratospheric Magnificent Seven. Historically, midterm election years are the most challenging within the four-year presidential election cycle, with the two middle quarters consistently producing negative returns. Why? In the post-war era, the party in power has typically lost seats, creating investor angst about fiscal policy during the sitting president’s final two years in office. 

Investment fundamentals matter most We at Federated Hermes have a constructive view. We project above-consensus economic growth, lower-than-expected inflation and an upturn in both business and consumer confidence. Our recommendation is to embrace the equity market’s likely seasonal choppiness in 2026 and to consider buying the dips. We forecast the broadening-out rally to continue, benefiting domestic small cap, domestic large- and mid-cap value and international stocks. Our year-end target for the S&P 500 remains at 7,800 in 2026 and 8,600 by year-end 2027. 

Healthy GDP growth We forecast full-year 2026 GDP growth of 2.9%, considerably higher than the Blue Chip consensus of 1.9%. Six reasons make us optimistic: 

  • Consumer strength Driven by the wealth effect from surging stock and home prices, high-end consumers continue to spend. The top 10% of Americans typically account for half of this, which in turn accounts for 70% of GDP. We also expect stressed low-end consumers to buy more due to tax incentives from President Trump’s One Big Beautiful Bill Act, which should result in noticeably larger refunds. America250, the Winter Olympics and the global soccer tournament should also boost economic activity. 
  • Corporate spending accelerating The 100% expensing of corporate capex on capital goods, factories and R&D included in the Act has already spurred productivity from a loss of 1.8% in the first quarter of 2025 to a gain of 3.3% in the second quarter. We expect that positive trend to continue this year. 
  • Housing trough Residential construction has been in recession during five of the last six quarters, and affordability has not been this bad since the mid-1980s. But with lower interest rates due to Federal Reserve easing and positive real wages, we think this year’s spring and summer selling season could be stronger. 
  • Less drag from trade The trade deficit hit a record $1.2 trillion in 2024, costing the US 51 basis points in lost GDP growth. In the first quarter of 2025, the goods deficit swelled to an annualized run rate of $1.54 trillion, which cost another estimated 65 basis points. But after the implementation of the Trump administration’s tariff policies in April 2025, the goods deficit slowed to an annualized run rate of $760 billion over the six months from April through September, which cost the US less — an estimated loss of 32 basis points.
  • Inflation moderating Inflation metrics across the board have declined from 40-year highs in mid-2022 to four-year lows at present, a positive trend that we expect to continue: from its spike to a 40-year high of 6.6% y/y in September 2022, Core CPI declined to a more than four-year low of 2.6% y/y in November 2025. That is also our year-end 2026 forecast, lower than the Blue Chip forecast of 2.9%. Core PCE inflation peaked at a 39-year high of 5.6% y/y in September 2022 and declined to a four-year low of 2.6% in April 2025. While it rose to 2.9% in July and August (likely related to a one-time adjustment from tariffs), it slipped to 2.8% y/y in September. We expect this metric to decline further to 2.5% by year-end 2026, while the Blue Chip estimate is at 2.8%.
  • Pessimism rampant Despite good economic news, business and consumer confidence declined sharply last year. But with strong economic growth and lower inflation, we expect that trend to reverse in 2026: 
    • NFIB Small Business Optimism Index declined from a six-year high of 105.1 in December 2024 to a six-month low of 95.8 in April 2025 due to tariff mania. But it improved to 99.0 in November 2025. 
    • University of Michigan Sentiment Index plummeted from an eight-month high of 74.0 in December 2024 to a three-year low of 51.0 in November 2025, just above its record low (going back nearly half a century) of 50 in June 2022. December 2025 improved modestly to 52.9.
    • Conference Board’s Consumer Confidence Index plunged from a 16-month high of 112.8 in November 2024 to an 11-year low of 85.7 in April 2025, before improving to 89.1 in December 2025. 

Read more about our views and positioning at Capital Markets

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Tags 2026 Outlook . Monetary Policy . Markets/Economy . Equity .
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DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Magnificent Seven Moniker for seven mega-cap tech-related stocks: Amazon, Apple, Google-parent Alphabet, Meta, Microsoft, Nvidia and Tesla.

The Conference Board's Consumer Confidence Index measures how optimistic or pessimistic consumers are about the economy.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

Large-cap companies may have fewer opportunities to expand the market for their products or services, may focus their competitive efforts on maintaining or expanding their market share, and may be less capable of responding quickly to competitive challenges. The above factors could result in the share price of large-cap companies lagging the overall stock market or growth in the general economy, and, as a result, could have a negative effect on the fund's portfolio, performance and share price.

Mid-cap companies often have narrower markets and limited managerial and financial resources compared to larger and more established companies.

Small company stocks may be less liquid and subject to greater price volatility than large capitalization stocks.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results. 

This is a marketing communication. The views and opinions contained herein are as of the date indicated above, are those of author(s) noted above, and may not necessarily represent views expressed or reflected in other communications, strategies or products. These views are as of the date indicated above and are subject to change based on market conditions and other factors. The information herein is believed to be reliable, but Federated Hermes and its subsidiaries do not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. 

This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities, related financial instruments or advisory services. Figures, unless otherwise indicated, are sourced from Federated Hermes. Federated Hermes has attempted to ensure the accuracy of the data it is reporting, however, it makes no representations or warranties, expressed or implied, as to the accuracy or completeness of the information reported. The data contained in this document is for informational purposes only, and should not be relied upon to make investment decisions. 

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