MONTHLY MARKET MUSINGS

January 2026

Happy New Year

With the roller coaster that was 2025 now done, investors can exhale and breath a sigh of relief as the overall returns for equities were, in the end, very good. The media outlets provided many reasons for investors to seek out safe havens with their distressing doom and gloom headlines but none of that was grounded in reality and had everything to do with getting eyes on the articles to generate ad revenue rather than informing investors about the realities of the markets. The key takeaway for investors is to be wary of news headlines that try to appeal to their emotions, especially the emotions that fall within the greed-fear cycle. With that behind us, we can now focus on the new year and what that entails for the markets. While 2025 was the year to question everything AI and debate whether there was a bubble every week or so, it seems that many analysts and strategists are entering 2026 with a more positive view. The narrative is much more optimistic in regard to AI and there seems to be more of a general acceptance that we are not currently in a bubble despite equity prices being somewhat elevated.[1] One thing that could be a key driver of equities is the clarity of AI use that may begin to appear in 2026. Productivity improvements and the monetization of end-user applications may give the skeptics the comfort they have long needed to embrace the AI investment thesis. The initial stage output improvements and efficiencies created using AI should have a rather immediate impact on overall productivity which should further support growth. The counter argument is that these efficiencies will eliminate jobs in the process. While this is likely to happen to some degree, the initial signs seem to suggest that AI application usage within many jobs has been a tool to increase a workers' proficiency rather than a certainty of job replacement.

In 2025, there were some stronger-than-expected instances of economic growth. While overall forecasts are pointing to a slight moderation in the level of growth in the U.S. year-over-year, the expectation, in general, is for further GDP growth. Core inflation should continue to move towards the U.S. Federal Reserve's key target rate of 2%. The U.S. labour markets may see some slower growth in the early part of the year,[2] according the JP Morgan, but that initial slowing in employment growth due to the lag from a number of government policy decisions (tariffs, immigration, etc.) is expected to improve as we shift into the second half of 2026. Much of the trade tension is likely to de-escalate and become less of a driver for the market as the initial impact of the average baseline tariff of 15% is well-established in market forecasts and accepted at this stage. Geo-political tensions should ease further as well given the progress towards resolutions and work towards calming political differences in the past twelve months. The U.S. Federal Reserve (Fed) is expected to cut interest rates by another 0.5% (two quarter point cuts throughout 2026) bringing the Fed Funds rate to 3.0%.[3] This seems to be more than likely the minimum amount of cuts that we will get when we consider the fact that there is going to be some potential weakness in the employment numbers, possible disinflation, and a change in Fed leadership in the first six months of 2026. While the Fed independence may come back into question with the new Fed chair appointed by President Trump, who has been very vocal about wanting lower rates, it is unlikely that the new chair would not be inclined to cut at least once. So, this suggests that if U.S. employment slips in the first few months of 2026 while the current chair, Jerome Powell, is in place and the market gets its two 25-basis point cuts, then the new chair would have no further room to cut according to current expectations even though he was brought on to be a more dovish Fed chair. The more likely scenario is that if there are two cuts in the early months of 2026 with Jerome Powell at the helm, then we would probably see at least another cut with the new more dovish Fed chair. U.S. fiscal policy will be another driver that will support U.S. equities and economic growth in the near term via lower taxes and looser financial regulations. The benefits of these policy changes should be felt in 2026.
 

Canada is a bit of a different story when it comes to its fiscal and monetary policy. Fiscally, the government of Canada has included some stimulative elements in the budget but in general, the approach is less expansionary than the U.S. and thus would not likely produce the same level of growth. The Bank of Canada (BoC) has seemingly reached its extended pause phase, and most economists believe that the cutting cycle is done.[4] Some are even expecting hikes late in 2026 due to the inflation pressures. Growth will be the main deciding factor for the BoC. While currently there is a bias towards a hike following the extended pause, it could tilt in either direction. Basically, if growth continues as expected and inflation begins to creep higher again due to wage growth, weaker productivity, and higher costs of living due to tariffs, etc. then a hike would be on the table, on the other hand if growth slows too much due to the current slower population growth, high unemployment, and lower immigration among other factors, then the BoC would tilt in favour of another cut. At this stage, we can assume that overnight rates will likely not deviate too far from current levels and that Canadian bond yields will begin to reflect the projected direction of the BoC's next move in the coming months. The mandatory review of CUSMA (Canada-United States-Mexico Agreement) this year could also have a large impact on the Canadian economy depending on how much the resulting changes differ from the current agreement. For 2026, we expect weaker growth in Canada which should be reflected in the equity performance relative to the U.S. and that should translate into more upside in U.S. stocks. While the commodities/materials sector (mining and metals in particular) do have the ability to contribute heavily to higher returns in Canadian equities, we do not think that the level at which they supported the Canadian market in 2025 will repeat itself this year.

Overall, for 2026, most analysts and strategists have expectations of high single-digit to low double-digit returns on the main indices (S&P 500 index and S&P/TSX Composite index).[5][6] Our view would be somewhat aligned with this range; we believe that there is a possibility that returns are front-loaded in the first six months of the year. Meanwhile, the back half could see some more muted returns. In Canada, should the BoC hiking scenario begin to take shape, this could weigh on equities. In the U.S., the November mid-term elections and the potential for the Fed to have finished its easing cycle at that point, may bring higher volatility and result in investors looking towards risk-off assets. Overall, we continue to favour equities at this time and believe that returns will be best achieved within this asset class in 2026.

JAY SMITH, CIM®, FCSI®

Senior Portfolio Manager & Senior Wealth Advisor    

jay.smith@cibc.ca

BRAD BROWN, MBA, CFA®
Portfolio Manager & Associate Investment Advisor

brad.brown@cibc.com