By Gary C. Sanger, Ph.D., CFA
Welcome to 2026! The Federal government shutdown underway at the end of last quarter ended on November 12, lasting a record 43 days. However, funding for most of government was only extended until January 30 under a temporary resolution, so another shutdown is possible. According to the Bureau of Economic Analysis, US real annualized GDP expanded by a surprising 4.3% in Q3 following a very strong 3.8% in Q2. The gain was due to strong consumer spending and a lower trade deficit. Projections for full-year 2025 GDP growth range from 1.8% to 2.0%. Projections for 2026 are similar but are subject to high uncertainty. The Conference Board’s Leading Economic Index dropped by 0.3% in September to 98.3 following a decrease of 0.3% in August. The Index has fallen 2.1% over the past six months. Declines in the LEI are intended to signal slower GDP growth, but not necessarily recession. Details in key areas follow below.
Consumers – Conditions in the consumer sector have been reasonably steady over the fourth quarter with a mix of plusses and minuses. The Bureau of Labor Statistics reported that the unemployment rate rose to a four-year high of 4.6% in November, up from 4.4% in September. And new job creation came in at a weak 64,000 for November. Job creation has been essentially flat since April. One positive is that initial jobless claims dropped unexpectedly to 199,000 for the week of December 27. Claims have dropped for seven of the past eight weeks. The Bureau of Economic Analysis reported that personal spending increased by 0.4% in September while personal income increased by the same amount. The Conference Board’s Consumer Confidence index fell from 92.9 in November to 89.1 in December, for the fifth monthly decline. Despite the poor confidence US hourly wages are up 3.5% year-over-year, exceeding inflation.
Businesses – Conditions in the business sector have improved marginally in Q4 and services are much stronger than manufacturing. Due to the government shutdown, the Bureau of Labor Statistics has not released Q3 labor productivity numbers. The Federal Reserve reported that industrial production increased by 0.2% in November and it is 2.5% above its year-earlier level. The US Institute for Supply Management manufacturing index decreased to 47.9% in December for the 10th straight month of contraction. The ISM services index increased to 54.2%, up from 52.6% the previous month. The neutral number between expansion and contraction for both ISM indices is 50%.
Government – On the fiscal side the Congressional Budget Office estimates that the government shutdown lowered Q4 real GDP growth by 1.5 percentage points. And that estimate is consistent with the Atlanta Fed’s forecast of 2.7% real growth for Q4. Another shutdown could similarly affect Q1 2026 growth. On the monetary side the Federal Reserve cut its target federal funds rate two additional times in Q4 to a current target range of 3.50% – 3.75%. The Fed decided that downside risks due to a weakening labor market outweighed upside inflation risk. The PCE inflation rate for September was 2.8% year-over-year, modestly above the Fed’s target of 2.0%. At the December meeting the Federal Open Market Committee (FOMC) was more divided than in the recent past, so there is uncertainty over whether we will see further cuts in 2026.
International – The December OECD Economic Outlook projects that global real economic growth will be 2.9% for 2026 and 3.1% for 2027. These forecasts are slightly more optimistic than the OECD’s previous Outlook. Inflation is projected to be down to target levels by 2027 in most major economies. The effect of tariffs is predicted to soften by 2027. Finally, progress has been made on a complex global minimum corporate tax agreement that has the potential to improve international trade activity.
Markets – The US equity market was up again in Q4 and performed very strongly for the third year in a row. The broad market, measured by the S&P 1500 was up 2.58% for the quarter and 17.02% for the year. Large-cap stocks (S&P 500) were up 2.66%/17.88% respectively, mid-cap stocks (S&P 400) were up 1.64%/7.50% respectively and small-cap stocks (S&P 600) were up 1.70%/6.02% respectively. Global equity markets were also positive, with the S&P World Index up 3.18%/22.05% respectively. For fixed income, the S&P US Aggregate Bond Index was up 1.04%/7.07% respectively. All numbers are total returns including reinvested dividends or interest.
Closing – While there is a lot of discussion about historically high US equity prices, analysts surveyed by FactSet expect 15% earnings growth this year which could support higher stock prices. The AI investment boom continues, and we will soon see if real productivity gains result. In geopolitics there is new instability in Iran and Venezuela. Fortunately the two combined account for less than 5% of global oil production, and oil prices remain near a five-year low.