The most accurate groups from last year; Yardeni, Deutsche, Capital Economics, and Wells Fargo are again clustered at the higher end of the range.

But I think it is worth exploring again what First Trust is seeing that everyone else isn’t. Below is an excerpt from their recent 2026 outlook::

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“Yes, we have been bearish on the market because our models (as well as every other model we know of) say the market is over-valued. This does not mean every stock is overvalued. It means the indexes are trading at multiples which historically are unsustainable. How did we get here? Since the bottom of the economy during COVID in 2020, corporate profits are up 96.2%, S&P 500 reported earnings are up 140% (they won at the expense of small business closed during COVID), while GDP is up just 55.8%. But the total return for the S&P 500 is 189.5%! The stock market has outperformed earnings and economic growth and is trading at valuation metrics at the high end of the historical scale. Profits are also at a record level of GDP.

Many argue that AI and robots will boost profits significantly but the math on these predictions is somewhat suspect. We are not saying AI won’t change the world, it will, but the near-term projections seem overrated.

Our capitalized profits model discounts earnings with the 10-year Treasury yield to calculate fair value. As of the third quarter, using a 4.0% 10-year Treasury yield and corporate profit growth of 10%, the S&P 500 is worth just 5,000. Our forecast for 2025 was a year-end target of 5,200. We know, we were way too low…the S&P 500 is trading at 6,900. In other words, we think the market is overvalued by roughly 25%.

This 25% figure can be affected dramatically by the level of the 10-year yield and profits. With the Fed cutting rates this year, a 10-year yield of 3.5% is not out of the picture. If that were to happen and profits also grew 10%, the market would still be overvalued by 17.5%. If AI boosted profit growth to 20% and the 10-year fell to 3.5%, the fair value of the S&P 500 would rise to 6,200. In other words, we can’t reasonably summon a forecast of a rising stock market in 2026.”

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Tough words for the bulls. Much of what they say makes a lot of sense, but they mention something important to explore – that “our models (as well as every other model we know of) say the market is overvalued.” I’ve discussed this before in prior letters, but it bears repeating; there is a model that shows that the market is not all that overvalued. The profit margin adjusted price to earnings ratio.

Profit margins – the percentage of each revenue dollar a company turns into profit – have been steadily rising for the S&P 500 over the past 40 years, going from approximately 10% in the early 2000’s to nearly 15% today. It would make intuitive sense that an investor should be willing to pay a higher price for a dollar’s worth of earnings (the P/E ratio) if your next dollar of revenue was going to provide more of said earnings than it did in the past.

A group called Duality Research published this on their Substack and put real numbers to an idea I have been talking about for quite some time. Today’s companies are simply better at making money and generating value for shareholders than they were in the past. Adjusting for the profit margin factor, Duality calculates that the profit margin adjusted forward price-earnings ratio is not 22 or 23, but more like 16 or 17, which is right in line with historical averages.

Furthermore, the multiples in what had been considered the “frothy” tech sector declined by 8% in 2025, with the entire performance of the sector coming from earnings growth. For the S&P 500 as a whole, valuations only expanded 2.5% this past year. The verdict: 2025 performance was an earnings driven, fundamentally sound rally, not a speculative frenzy.

None of that means markets can’t fall in 2026, but I think looking at today’s valuations as drastically outside historical norms is a mistake.

Below are the price returns of each sector on the left, the EPS growth in the middle, and the multiple growth (valuation change) on the right.

Furthermorethanthat, the growth in debt being used to fund the buildout of infrastructure in the 90’s dwarfs the growth of debt being used to fund the AI buildout this time around. Most of the investment being made in data centers and AI development is being done with free cash flow. Below we see the cumulative growth of debt in the “technology, media, and telecom” sectors in the dot-com boom on the left and the AI boom on the right.

Anecdotes abound on how AI is enhancing the day-to-day activities of workers in every industry. (I use Gemini pretty much every day). But we are now starting to see measurable productivity gains in big companies as revenue per worker has broken out to new highs after a 15 year stall.

Then there is the growth spurred on by capital spending itself. And there is no sign that it is letting up. In fact, it is accelerating.

At some point these investments will need to pay off in a big way. But what these companies have seen thus far is enough to keep their foot on the gas.

Other potentially significant tailwinds in 2026 will be the trifecta of:

• Fiscal impulse of the OBBA (One Big Beautiful Bill Act) and associated tax incentives kicking in for the 2026 tax year.
• Normalization of tariff and trade policy in an election year – while we are likely to see continued chaotic policy, we expect less of it as we get closer to a crucial midterm election. Some measure of certainty on the path forward will help.
• Easing monetary policy from the Federal Reserve in the form of lower rates and the end of quantitative tightening.

We could write a whole letter on just Washingtonian maneuverings, but I think we are all exhausted and I’ll spare you. Net: what were headwinds we persevered through in 2025 could be tailwinds in 2026.

Next, we can point to several technical market factors that would indicate a continued bias to the upside.

The popular “Dow Theory” triggered on January 6th when the Dow Jones Industrial average AND the Dow Transports index both made new highs.

The 17 other times this has triggered since 1927 saw positive S&P returns one year later every time but once.

The history of Federal Reserve rate cuts near all-time highs has been a remarkably positive experience over the last 50 years. Since 1980, it has been a perfect 20 out of 20 positive performance one year out.

Mid-term election years are the worst performing of a 4 year presidential cycle, often experiencing sharp drawdowns, but those bottoms have been short-lived, and returns off those mid-year declines into the third year of a presidential term have been well above average and positive 100% of the time going back to 1950.

Despite the strong performance of international markets in 2025, the Europeans continue to opt for a heavy hand in regulating economic actors, serving as a wet blanket on top of potential growth. This is perhaps best evidenced by Alphabet’s (Google’s parent company) recent quarterly earnings report in which they have added a regular line item on their balance sheet for accrued “European

Commission fines”, which in the quarter-ending September 30th, had ballooned to $10.5 billion.

We are positive on emerging markets but don’t see much growth and opportunity coming out of Europe.

The things I am most worried about are slower simmering, but also more potentially existential, eroding the foundation on which a prosperous market and economy are built. They include the steady and continued decline of public trust in our government institutions and higher education, the burgeoning national debt and unwillingness of either party to address persistent deficit spending, and the decline of household formation, decreasing birth rates, and an ever-widening gap between income and wealth strata present grave risks to our collective future prosperity.

Gallup has been polling Americans for decades on their trust in various institutions. From 2005 to 2025, trust in organizations of all types has declined. Perhaps we are more cynical these days as a matter of course, but these numbers below are not the sign of a society improving itself and creating opportunity for future generations to flourish. They are signs of a society in decline.

Question asked: how much trust and confidence do you have in each one — a great deal, quite a lot, some or very little?

While corporate and household balance sheets look pretty good relative to history, our nation’s balance sheet is another story. 2026 will be the fourth year in a row and sixth of the last seven with a $1.5 trillion budget deficit.

And in an environment of hollow institutions, decreasing trust, and widening inequality it is no wonder that the next generation of prime-age workers are not participating in the markers of American exceptionalism that defined the second half of the twentieth century.

So, while capital allocators, investors, and high-income earners see a deep ocean of prosperity laid out in front of them, the shimmer on the surface is potentially hiding that it is in fact just inches deep. For the long-term health of our economy, we need to address these persistent and broad reaching problems.

The good news is that the same technology that divides people can also bring them closer together, capital horded can be capital put to productive use, and our country was designed to be resilient when faced with strong prevailing political currents that threaten to erode the foundations on which it was built.

We just have to all decide it is worthwhile to do so.

I’ll end with a passage from Matt Topley’s annual letter, recently published, which echoes these sentiments:

“Markets fluctuate. Forecasts fail. Speculative excesses come and go.

But demographics and education change slowly and when they move in the wrong direction, the consequences compound over decades, not quarters. If Americans want to worry about something beyond the next election cycle or the next market pullback, these are the trends that deserve attention.

They may not dominate headlines, but they shape the future far more reliably than any market prediction ever could.”

With abundance,

Zachary S. Mineur CFA, CFP®

Chief Investment Officer

Independence Square Advisors

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