2026 I: What Will Likely Go Right?The Roaring 2020s remains our base-case scenario. For 2026, we are raising our subjective odds of this prospect from 50% to 60%. We are less concerned about a meltup/meltdown scenario now, so we are lowering the odds of that from 30% to 20%. We are keeping our bearish scenario at 20%.1. Growth Case StrengthensIn our base-case scenario, real GDP should grow 3.0%-3.5% next year, following this year’s likely gain of 2.0%-2.5% (Fig. 1 below). We expect the labor force to increase by FiTrump repeatedly has proposed sending $2,000 “dividend,” or “rebate,” checks to Americans, funded by revenue collected from increased tariffs on foreign goods.He has specified that these payments would go to “low- and middle-income” citizens, explicitly excluding “high-income people.” During a December 2 cabinet meeting, Trump reiterated the plan, telling officials and the press that the government would be “giving a nice dividend to the people” in 2026 because the US has “taken in literally trillions.”The President cannot unilaterally spend tariff revenue on checks; Congress must pass legislation to authorize the payments. No such bill has been passed or even introduced. If the Supreme Court were to rule against the administration’s tariff authority, the revenue source for these checks could disappear.Should that happen, administration officials claim they have a backup plan to raise revenue through tariffs. But since tariffs have increased the cost of imported durable goods this year, the administration may be forced to lower some tariffs to address the affordability crisis.2. OBBBA will be stimulativeThe “One Big Beautiful Bill Act” (OBBBA), passed in July 2025, will stimulate the economy in 2026 primarily through a massive wave of tax refunds and renewed business incentives. Because the bill passed mid-year but made many tax cuts retroactive to January 1, 2025, most workers did not see the benefits in their weekly paychecks. Instead, these benefits will arrive as lump-sum payments when Americans file their taxes in early 2026.The OBBBA allows workers to deduct up to $25,000 in tip income. There’s a deduction of up to $12,500 (single) or $25,000 (joint) for overtime pay. A new deduction allows write-offs of up to $10,000 in interest on loans for personal-use vehicles. There’s an additional means-tested $6,000 deduction for individuals and $12,000 for couples over age 65. This provision was sold as “eliminating taxes on Social Security.”The bill restores several corporate tax advantages from the 2017 Tax Cuts and Jobs Act that were expiring or phasing out, aimed at encouraging companies to spend money on expansion in 2026. Companies can immediately write off the full cost of new equipment and machinery (rather than spreading it out over years). This is intended to incentivize heavy capital investment in 2026. It also restores businesses’ ability to deduct domestic research and development costs immediately (retroactive to 2025), improving corporate cash flow.The Congressional Budget Office estimated that OBBBA will boost real GDP growth by 0.4% in 2026 from 1.8% to 2.2%.3. Baby Boomers will continue to retire and spend their nest eggsBaby Boomers will be 62-80 years old in 2026.They will continue to retire. They will be spending the retirement funds they have accumulated over their working years. The Baby Boomers are the largest and wealthiest retiring population cohort in history. Collectively, they have $85.4 trillion in net worth, accounting for 51.0% of the household sector’s total net worth.They own $27.4 trillion in equities and mutual funds. So the bull market in equities is providing them with a powerful positive wealth effect on their consumption.4. Monetary stimulus should kick inThe Fed has cut the federal funds rate by 150bps since September 2024. In his October press conference, Fed Chair Jerome Powell stated, “Now we are 150 basis points closer to neutral, whatever that may be, than we were a year ago.”He implied that the Fed has done enough to stimulate the economy. Nevertheless, recent dovish comments by a few Fed officials have convinced the financial markets that another 25bps cut in the federal funds rate is coming following the December 9-10 FOMC meeting.The Fed terminated its latest quantitative tightening (QT) program on December 1. The decision was announced following the FOMC meeting on October 29. This shift marks a transition from a policy of actively shrinking the balance sheet to a “neutral maintenance” phase. The Fed halted the balance-sheet decline at approximately $6.6 trillion by stopping the monthly runoff of Treasury securities.Instead of letting these bonds mature without replacement as before, the Fed began reinvesting the proceeds into new securities to maintain the balance sheet’s current size.The move was largely preemptive, driven by indicators that banking reserves were approaching the lower end of “ample” levels and signs of emerging stress in overnight funding markets. This pivots the Fed from a “headwind” on liquidity to a neutral stance, which analysts have noted is intended to prevent a repeat of the repo market turmoil seen in September 2019.Milton Friedman famously claimed that monetary policy has a long and variable lag on the economy. If so, then, the latest round of monetary easing should boost economic growth in 2026.5. Technology boom & onshoring should fuel capital spending boomThe “Magnificent 7” companies (Microsoft, Amazon, Alphabet, Meta, Apple, Nvidia, and Tesla) are projected to spend over $500 billion on capital expenditures in 2026. They’re not bound by any official commitment to spend that much next year, but their managements’ forward guidance to Wall Street analysts through late 2025 indicates plans to accelerate their aggressive investment in AI infrastructure.Most of the spending is expected to come from the four companies building the massive data centers required for AI—Microsoft, Amazon, Alphabet (Google), and Meta—all of which have explicitly stated that their 2026 spending will likely be higher than 2025.Onshoring should be another source of strength in capital spending. Trump’s tariff negotiators have extracted commitments from foreign governments and companies to build manufacturing facilities in the US in return for lower US tariff rates. A White House webpage lists high-dollar private-sector investment commitments “[m]ade possible by President Trump’s leadership.” It claims that Trump secured almost $10 trillion in total US and foreign investments.2026 II: What Could Possibly Go Wrong?We’ve lowered the odds of a stock market meltup scenario from 30% to 20%, as noted above. We are doing so mostly because everyone has been asking the same question in recent weeks: “Is AI a bubble?” The widespread concern is that the high valuations of AI-related stocks represent a bubble that might soon burst, with bearish consequences for the overall stock market.In turn, the resulting negative wealth effect would likely depress consumer spending, triggering a recession. The economic downturn would be exacerbated if the hyperscalers are forced to slash their spending on AI infrastructure.The selloff in stock prices in late November was triggered by such worries, but the market quickly rebounded in recent days. There are lingering concerns about the AI spending boom, but they reduce the likelihood of a meltup/meltdown scenario, in our opinion, as they put a lid on valuation multiples.So what else could go wrong in 2026?1. Bond Vigilantes could trigger debt crisisThe OBBBA’s tax refunds and tax incentives undoubtedly will swell the federal deficit in fiscal 2026. Doomsayers have long been predicting a sovereign debt crisis in the US. Might 2026 be the year they finally get it right? Maybe, though we doubt it.The Bond Vigilantes are currently busy instigating sovereign debt crises in Japan and the United Kingdom. Soaring bond yields in those two countries could put upward pressure on yields in other countries with extremely high government debt-to-GDP ratios. That might include the US. Indeed, the 10-year US Treasury bond yield has remained above 4.00% in recent days as short-term interest rates fell because the odds of another Fed rate cut on December 10 have increased.Last year, the Fed cut the federal funds rate by 100bps from September through December, but the bond yield rose as much.The Fed has been trying to be less restrictive, but the bond market is offsetting the Fed’s intentions. Nevertheless, the bond yield isn’t likely to spike next year since the US Treasury demonstrated in November 2023 that it is ready, willing, and able to practice yield-curve control by funding more of its debt in the Treasury bill market if necessary to bring bond yields down.2. Private credit market could blow upSo far, the yield spread between high-yield corporate bonds and the 10-year Treasury bond isn’t showing any sign of distress. However, stock market investors recall that the Great Financial Crisis was caused mainly by problems in the subprime mortgage sector of the credit market. Now, the widespread concern centers on the private credit market.We aren’t as concerned as many seem to be because the Fed is easing. That helps borrowers in that market to refinance their loans at lower rates. In addition, such loans are held by creditors who recognize the risks they are taking and have large and diversified portfolios of such loans.If a few default, that reduces the rate of return on their portfolios. The result isn’t likely to be a systemic problem that triggers an economy-wide credit crunch and recession. Meanwhile, we will be monitoring the performances of a few of the private credit ETFs.3. Stock market could melt downIn our Roaring 2020s scenario, the economy continues to grow through the end of the decade without a recession. If so, then the bull market in stocks should remain intact. However, we can’t rule out a meltup/meltdown scenario like the one that occurred during the late 1990s and early 2000s. That experience demonstrated that a plunge in the stock market can cause a recession by depressing consumer and business capital spending.4. American consumers could retrenchOur optimism about the rest of the decade has been bolstered by the resilience of real GDP and corporate earnings during the first six years of the decade. Both continued to rise to record highs despite lots of challenges.The latest challenge is the weak pace of employment gains. Layoffs remain relatively low, but finding a job has gotten harder. That’s depressing consumer confidence, as is the affordability crisis. So far, consumer spending has held up remarkably well thanks to discretionary spending by upper-income consumers and retiring Baby Boomers, as we anticipated. But we acknowledge that consumer spending’s resilience will be tested in 2026.5. Productivity could fizzleWe are counting on productivity growth to be strong over the remainder of the decade. There are skeptics, as discussed in an article in this week’s Barron’s titled “Productivity Is About to Slump—and AI Won’t Come to the Rescue.” They believe that recent gains in productivity are not sustainable.They question whether AI will have any significant impact on productivity anytime soon. They warn that technological innovations like AI can reduce productivity growth at first, before the benefits accrue years or even decades later. We aren’t budging: We remain on the optimistic side of this debate.6. China could invadeTaiwan, and Russia could invade Europe. Geopolitical crises usually create buying opportunities in the stock market. However, if China invades Taiwan or Russia invades Europe, all bets are off.Original Post