The Odds Are Changing: 2026 Is a Market for Investors, Not Gamblers

If the last few years felt a bit like walking through a casino where almost every table was paying out, 2025 has been the point in the night when the lights come up a bit and you notice the house edge again.

From 2020 through 2024, the equity market rewarded almost any risk you took. In that period, more than half of S&P 500 companies delivered annualized returns above 15%, and about 90% had positive annualized returns. In other words, simply “putting chips on the table” worked unusually well.

This year has been different. As 2025 winds down, around 40% of the S&P is heading for a negative year.

That shift in the odds is the core of how we’re thinking about 2026. The coming year looks less like a casino and more like an investor’s market. You win not by chasing every hot trade, but by sizing positions thoughtfully and focusing on high-probability outcomes.

Inflation’s Storm Has Passed; Labor Is the New Pothole

The good news first: the inflation storm that dominated the last few years looks largely behind us.

Shelter inflation, which had been a source of stickiness, has moderated back toward pre-COVID trends when you look at six and three-month measures. Underlying price volatility tells a similar story: the standard deviation of month-over-month core inflation is back in line with the remarkably stable 1990–2020 period.

Tariffs added noise, but even there the data suggests a one-time level shock. The data shows roughly 0.5 percentage points of tariff pass-through already behind us in core PCE inflation, and perhaps another 0.4 points to come—important, but not grounds for a new inflation spiral. Markets seem to agree, five-year inflation break evens are hovering around 2.3%, a level that would have looked almost ideal to policymakers in many prior cycles.

If inflation is no longer the central problem, what is? Labor.

Behind the headline numbers, virtually every measure of underlying slack is moving the wrong way. The share of workers who are “marginally attached” to the labor force or not in the labor force but wanting a job, has been drifting higher. Layoff announcements show that roughly 70% of October’s job cuts were framed as efficiency initiatives—cost-cutting, automation, restructuring—rather than classic cyclical weakness.

At the same time, healthcare has done almost all of the heavy lifting for job creation. The three-month moving average of total job growth excluding healthcare is now negative for the first time outside of recession in more than 25 years. Put differently, the rest of the economy is no longer creating net new jobs, even as the headline payroll numbers still look respectable. That support is also beginning to fade, as hiring in healthcare slows toward more normal run-rates.

The October and November jobs reports reinforce this picture. Hiring has clearly downshifted, and the underemployment rate has risen to 8.7%, the steepest increase since the pandemic. Wage growth is also rolling over toward the mid-3% range year-on-year. This combination of slower hiring, a clear increase in slack, and moderating wages is not the backdrop for keeping policy restrictive.

An equally important part of the story is affordability. Even with inflation cooling, many key prices (housing, transport, insurance, basic services) have reset higher and stayed there. Higher rates have also made homeownership less accessible. The result is a more uneven distribution of wealth and consumption. Higher-income households can mostly absorb the shock, while lower and middle-income households are feeling a much tighter squeeze.

It’s no surprise, then, that household surveys show expectations for the job market over the next year at some of the worst levels on record.

Taken together, this is why we’ve been arguing that the Fed’s challenge in 2026 is no longer about taming inflation - it’s about avoiding unnecessary damage to the parts of the economy that are already under pressure. With the inflation storm largely behind us and labor potholes ahead, we reiterate the need to move away from restrictive policy toward a more balanced stance.

AI: A Cost Revolution More Than a Revenue Story

One of the reasons the labor backdrop feels so different is that technology is increasingly being deployed to reduce headcount and raise productivity, not just to build new products.

Corporate commentary this year has been remarkably consistent. Across industries, management teams are talking about “being more efficient,” “reducing bureaucracy,” “removing layers,” and “shifting resources” toward their “biggest bets.” The language varies by company, but the theme is the same. Automation and AI are central levers in cost management and earnings growth.

The long-term implications of this are profound. Today, labor accounts for roughly 55% of total business-sector costs. If AI and related technologies can reduce labor’s share of corporate costs by even 5%— from 55% to 50%—and if 75% of those savings accrue to corporates and 25% to AI service providers, the present value of those cash flows is enormous. On aggregate, that would generate roughly $1.2 trillion in annual labor cost savings, translating into about $878 billion in incremental after-tax corporate profits each year. The present value of the corporate piece alone is on the order of $82 trillion, with another $27 trillion accruing to AI providers.

For perspective, that $110 trillion combined present value doesn’t come from new revenue lines. It comes from shifting cost structures, with labor as the obvious loser. Mechanically, a 9% reduction in labor costs translates into roughly 31% higher earnings for corporates. The market doesn’t need every sector to experience that magnitude of change for the equity and credit implications to be significant.

This is why we continue to see AI as, first and foremost, a cost and margin story. Over time, it should support higher returns on equity for the companies that deploy it well.

For investors, the key is to own the beneficiaries of that transition on both the equity and credit side - businesses with scalable models, durable cash flows, and clear plans for harnessing AI to lift productivity over time.

2026: Strong Growth, Weaker Labor, More Dispersion

So where does that leave the macro regime as we look into 2026?

A few points stand out:

• Growth can remain resilient even as labor softens. Real private domestic final purchases continue to point to an economy growing in the neighborhood of 2% in real terms, boosted by robust investment in intellectual property, software, and the AI-related build-out of data centers and power infrastructure.
• Policy is still broadly supportive. Fiscal deficits remain large, liquidity is not scarce, and the Fed should continue moving the rate to neutral, all of which provide a meaningful cushion against a classic demand-side recession.
• Yet the distribution of outcomes is widening. After a decade-plus of financial repression, with rates anchored at the floor, the return to a higher cost of capital is re-introducing dispersion—across sectors, across balance sheets, and across countries. We expect more frequent idiosyncratic defaults and downgrades, even if the aggregate macro data remains respectable.

In that world, 2026 looks like a year in which both upside surprises and downside accidents become more common. It is, in many ways, the best opportunity we’ve seen since the Global Financial Crisis to play both sides of the distribution: to own high-quality income and durable growth where you’re being paid for the risk, and to be selective (and sometimes short) where valuations ignore fragility.

That’s fundamentally an investor’s market, not a gambler’s.

Letting Income and Time Do the Heavy Lifting

Even a healthy market doesn’t move in a straight line. We’ve already lived through several clear “air pockets” since 2023—periods where markets stepped down meaningfully before recovering—and there will almost certainly be more as the regime shifts from easy money and broad speculative upside toward something more normal and dispersed.

For us, those episodes are a reminder of what investing actually is. In a gambling framework, everything depends on the next spin of the wheel. You either win quickly or you walk away. In an investing framework, what matters is whether you own assets that can keep generating cash flow through those air pockets, and whether your time horizon is long enough to let that income and compounding work for you.

That’s why we put so much emphasis on durable yield. When markets wobble, income keeps showing up. Over time, that reinvested income does a lot of the work in pulling a portfolio back toward its longer-term path, even in stormy weather.

The key, in our view, is to go into this next phase of the cycle owning cash-flow-generative assets, accepting that there will be air pockets, and relying on income and time—rather than short-term luck—to drive outcomes.

Where We’re Putting Chips to Work

With that backdrop, how are we allocating capital as we head into 2026?

1. Quality Fixed Income

Investment grade credit does not look especially cheap today, so broad beta exposure is unlikely to be a major source of excess return from here. Where this part of the market remains interesting, in our view, is when you can lock in historically high yields lending to solid balance sheets, and in the opportunity to be tactical. That includes leaning into periods of heavy supply, particularly from large hyperscaler and infrastructure related issuers, when new deals offer concessions that are not consistently available in the secondary market.

Within that high-quality core, we also see a role for mortgages and securitized assets as part of the income sleeve. These markets can provide a meaningful yield pickup over government bonds with strong structural protections and diversification benefits, particularly when investors can be selective about structure and collateral quality.

2. Select High Yield and Private Opportunities

Below investment grade, we are more selective. A higher cost of capital and a more discriminating market should translate into more defaults and downgrades among weaker issuers.

Against that backdrop, we prefer idiosyncratic opportunities—stronger balance sheets, customized protections, and efficient parts of the capital structure tied to cash-generative businesses—over broad exposure to the lowest-quality segments of the market.

Within that high-quality core, we also see a role for mortgages and securitized assets as part of the income sleeve. These markets can provide a meaningful yield pickup over government bonds with strong structural protections and diversification benefits, particularly when investors can be selective about structure and collateral quality.

3. Emerging-Market Debt as a Diversifier

We also see a role for emerging-market debt as an effective diversifier. Many emerging economies are on different fiscal and demographic paths than the U.S., and in some cases have been ahead of developed markets in lowering rates and fiscal deficits.

Select local-currency and hard-currency positions can help diversify the fiscal and rate risk embedded in a purely U.S.-centric bond portfolio, particularly when starting yields are attractive.

4. Equities on the Right Side of AI

On the equity side, the key question for us is who is on the right side of the AI cost revolution. A narrow group of large, AI-exposed companies has led markets for good reason, but dispersion is widening.

We focus on businesses with durable profitability, strong balance sheets, and credible paths to using AI to improve margins or deepen competitive moats—not companies that are adding buzzwords to their earnings calls. In a world where the rising tide will lift fewer boats, that quality and proof of concept filter matters far more than it did a few years ago.

From Gambling to Investing

If there’s a single message we’d leave you with as we head toward 2026, it’s this: the game has changed.

The period when nearly every chip you placed in the market seemed to pay off is behind us. Inflation is no longer the central issue. Labor dynamics and the distributional effects of AI now matter more, and policy is likely to move from overtly restrictive toward something closer to neutral. Growth can remain resilient, but dispersion and default risk are rising.

That’s an environment where gambling in markets offers much worse odds than it did a few years ago. Investing, by contrast, still offers very good odds: owning durable income, strong balance sheets, and businesses on the right side of the productivity revolution, and then giving those positions time to compound. In our view, the opportunity now belongs to those willing to act like investors, not gamblers — leaning into selectivity, patience, and discipline in a market that is once again distinguishing between quality and everything else.

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