Published December 26, 2025
Below we continue our presentation of Schwab’s 2026 Outlook. The final piece considers AI and the outlook for markets. Here we go:
AI arms race and “leapfrog” effect
The Bloomberg-created visual below has been making the rounds, rightly so, as it does a terrific job laying out the circular financing concerns in the AI ecosystem. The primary concern is that it creates a self-reinforcing, potentially unsustainable loop of investment and demand that may obscure genuine market value. This structure typically involves a supplier (e.g., a chipmaker or cloud provider) investing capital into an AI company (its customer), which then uses that money to purchase the supplier’s products or services.
While this accelerates innovation and infrastructure build-out, critics worry it artificially inflates revenue and valuations, as the capital is simply circulating between a few interconnected companies rather than being driven by broad, external user demand—elevating the comparison to the dot-com bubble in the late 1990s (then referred to as vendor financing). We expect these concerns to persist in 2026.
AI goes ’round and ’round
Source: Bloomberg News, as of 10/8/2025.
All corporate names and market data shown are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.
We believe the market could reward AI adopters more than AI enablers, with adopters positioned to benefit by locking in measurable gains in efficiency and innovation. Early adopters are seeing tangible cost reduction from automating routine tasks and driving revenue growth through improved customer satisfaction and faster product development.
This creates an AI-driven flywheel, where better data improves their AI models, accelerating their performance, and making it increasingly difficult for slower companies to catch up.
We don’t cover individual stocks but are regularly asked about the key players within AI. Below is a handy look at the major companies (both public and private) involved in the Enablers, Monetizers and Adopters categories—courtesy of our friends at BCA Research.
Source: Charles Schwab, BCA Research, as of 12/3/2025.
Enablers=firms providing the infrastructure needed to train and monetize AI models. Monetizers=firms who provide AI software and develop models. Adopters=the end users of the models/software. Entities in red are privately owned. All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.
Leapfrog effects
We do believe there will continue to be cannibalization and leapfrogging in play across the AI sphere in 2026, including less of an obsessive focus on cohorts like the Magnificent 7 (Mag7). Given that only two of its cohorts are outperforming the index so far in 2025, and our expectation of some market broadening, a monolithic approach increasingly does not make sense. Our friends at 22V Research (along with Lux Capital’s Josh Wolfe) recently put together two complexes that highlight this. The “GOOG Complex” has recently become the winner relative to the “OpenAI Complex” because the latter is more levered than the former. It potentially exposes some economic risk in 2026 associated with the sustainability of capital spending plans.
Complex leapfrogs
Source: Charles Schwab, Bloomberg, as of 12/5/2025.
Google AI Complex includes Alphabet, Broadcom, TTM Technologies, Celestica, and Lumentum. OpenAI AI Complex includes Nvidia, SoftBank, Oracle, AMD, Microsoft, and CoreWeave. Data indexed to 100 (base value=1/1/2025). An index number is a figure reflecting price or quantity compared with a base value. The base value always has an index number of 100. All corporate names and market data shown are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Past performance is no guarantee of future results.
Participation trophy
In part due to the expectation of a widening-out in terms of the AI theme, we expect ongoing rotations in 2026, but with greater participation under the surface of the capitalization-weighted indexes. Shown below is NDR’s history of the percentage of stocks outperforming the index over the rolling prior three months. Given the historically low current reading, some bounce-back is expected. This should provide a runway for improved relative performance for the combination of active vs. passive management, equal-weight vs. cap-weight, and small caps vs. mega caps. We don’t expect this in linear fashion; more likely in fits-and-starts.
Historically low participation
Source: Charles Schwab, ©Copyright 2025 Ned Davis Research, Inc.
Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at http://www.ndr.com/copyright.html, as of 12/5/2025. Dotted line represents current reading. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
Specific to small caps, we do believe investors will continue to look for opportunities away from just the mega caps, but not all small caps are created equal. It’s within this space specifically that we suggest an up-in-quality bias in terms of factor performance, with an emphasis on profitability, balance sheet strength, and reasonable valuations. This would reverse the 2025 trend given that the unprofitable cohort with the Russell 2000 is up 23% year-to-date, besting by more than double the profitable cohort’s <11% gain, per Bloomberg data.
Sector swings
Sector rotations have been violent at times this year, and we expect rotations to persist alongside fickle appetites of investors. Our current sector views are favorable towards the Communication Services, Health Care, and Industrials sectors. For more details on those, and our other ratings, check out our re-launched Sector Views.
Earn it!
The consensus outlook for S&P 500 earnings at both the sector and index level are below. We did a “heatmap” version of our oft-used LSEG I/B/E/S table, thereby highlighting a largely green 2026. As shown via the bolding at the right, eight out of the S&P 500’s 11 sectors have 2026 expected growth rates higher than 2025’s.
Source: Charles Schwab, LSEG I/B/E/S, as of 12/5/2025.
S&P 500 sectors shown. Sectors are based on the Global Industry Classification Standard (GICS®), an industry analysis framework developed by MSCI and S&P Dow Jones Indices to provide investors with consistent industry definitions. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data. Color scale applied to each sector row with dark green indicating highest y/y earnings growth and dark red indicating lowest y/y earnings growth. Bolded FY26 percentages indicate higher y/y earnings growth relative to FY25. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance does not guarantee future results.
Amidst the AI hype and mega caps’ increasingly large weight in the indexes, a less-discussed aspect of the market’s performance this year has been the lack of multiple expansion in the second half of the year. As you can see in the chart below, the forward earnings per share (EPS) estimate for the S&P 500 has made successive all-time highs since the low earlier this spring. Taking a back seat has been the forward price/earnings (P/E) ratio. In other words, the E has been doing the heavy lifting, which has put downward pressure on the P/E.
In general, an earnings-driven market tends to be healthy and has been much needed this year after multiples got back to cycle (and in some cases, all-time) highs. If forward earnings estimates continue their upward trek, we see the possibility of multiples continuing to move lower heading into 2026. In other words, the market’s P/E would be moving down for the so-called right reason (i.e., prices not falling rapidly). That might pave the way for some multiple expansion later in the year, especially if investors continue to have high conviction in the AI space.
Earnings to the rescue
Source: Charles Schwab, Bloomberg, as of 12/5/2025.
Dotted lines for forward P/E show upward trajectory from April-August and sideways trajectory from August-December. Dotted line for forward EPS shows upward trajectory from May-December. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
Crucially, and we make this point often (for good reason), a stretched multiple doesn’t necessarily translate into imminent downside risk for the market. Shown below is one of our favorite scattergrams, which plots the S&P 500’s forward P/E against the index’s return a year later. You can see that the relationship is a very weak -0.12—essentially insignificant. It underscores the important market truth that valuation is a horrible market-timing tool (as if a good timing tool even exists). As a real-time example, take the S&P 500’s forward P/E a year ago: a lofty 22.4. One year later, the index is up by nearly 13%.
Of course, that doesn’t say anything about the incredibly volatile ride we’ve had over the past year, which includes a bear market for the S&P 500 on an intraday basis. Perhaps that means the better way to think about high valuations is that they make the market more vulnerable to shocks. Higher multiples are generally consistent with optimistic (and at times, euphoric) sentiment, so skittishness tends to kick in at a more aggressive pace when negative news hits the wires. Since we’re in an environment of elevated multiples and sentiment—with policy risk not subsiding anytime soon—the bar for a pullback or mini correction in the beginning of 2026 is not terribly high.
Valuation says … nothing
Source: Charles Schwab, Bloomberg, 1958-11/30/2025.
Dotted line represents trendline. Correlation is a statistical measure of how two investments have historically moved in relation to each other, and ranges from -1 to +1. A correlation of 1 indicates a perfect positive correlation, while a correlation of -1 indicates a perfect negative correlation. A correlation of zero means the assets are not correlated. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
In sum
Year-ahead outlooks are interesting exercises in that they imply a fresh turning of the page when one year ends and another begins—as if the economy and market are not dynamic beasts that don’t necessarily care about the calendar. That said, what doesn’t change heading into 2026 is the sticky nature of macro forces like tariffs, the K-shaped economy, and a wobbly labor market. Some themes, like AI, are still with us but they’re changing in complexion. While we continue to see large numbers get larger in terms of deals and capital spending, we think there is runway for the AI adopters to continue to likely do well—allowing the market to churn higher but perhaps not at the pace it has this year.
Market Update
Stocks began this holiday-shortened trading week with +0.5% gains as investors hope for a “Santa Claus Rally” to push shares upward into year-end. Tuesday looked very much the same with a strong third quarter GDP report providing additional support for bullish investors. Another +0.3% lift in Wednesday’s abbreviated Christmas Eve session on news that Apple chief (and Nike board member) Tim Cook had made a substantial purchase of Nike shares. Coming back from Thursday’s Christmas holiday, stocks experienced quiet and mixed trading. Precious metals leapt once again with silver having jumped more than +40% month-to-date in a furious parabolic rally.
A quiet holiday week found stocks pushing to record highs with the S&P 500 (SPY) rising +1.43%. The Nasdaq 100 (QQQ) posted a +1.24% weekly gain. Small cap stocks (IWM) were flat on the week (+0.25%).
Warm wishes and until next year.