Market thoughts for 2026

We've learned the folly of attempting to predict things, and yet every living creature has to make predictions in order to survive. (An organism is a hypothesis of its environment, for one thing.) Whether you are an S&P 500 indexer, a Treasury bill doomer, or a value investor, you are making a prediction about the future. So here are some of our thoughts - just hypotheses - about what 2026 could hold.

There is a glut of oil. As we read third quarter earnings reports, we were startled by the production volume increases reported by oil producers, especially since the price of oil during the quarter was down about 14% from the prior year. As we write this, oil has dropped to $55.

Rents are falling, especially in the Sunbelt. The number of people per household (PPH) is pretty elastic - people can double up, give up second homes, move in with their parents, and so forth. The economy and job scene on the low end are tough enough that PPH is probably rising. Also, a significant number of people have been deported or self-deported, which reduces demand for housing.

Shelter (rent) is about a third of the consumer price index and energy is close to 10 percent. With rent and energy both falling, it seems likely that reported inflation numbers will be going down. Since energy is itself a major input into the other goods in the CPI basket, we probably have at least half the basket falling in price instead of rising. 

Falling inflation means that the Fed can keep cutting. Perhaps that allows the economy to hold together for 2026. Trump will certainly want it to, leading up to the midterms. Our CME fed fund futures have the FF rate at 2.75% to 3% by the end of 2026, which is two to three cuts from the current target of 3.5%. With wholesale gasoline down $1.61 per gallon and Trump picking a new FRB chairman, perhaps we should expect more cuts than two or three.

With more FF cuts but the ten year bond yield holdings steady, the yield curve is steepening. Commercial loan rates probably will decline but not as much as short term rates and deposit yields, which is great for banks' net interest margin. Community banks at 1x tangible book value would continue to do well, as long as credit holds up. (There's the potential for earnings yields of 12-14% to have wider margins on higher assets plus multiple improvement.)

Cheap oil and the economy holding together would be good for many types of businesses, but especially: airlines, hotel franchisors, online travel agents, consumer lenders, and consumer discretionary businesses of various kinds. If businesses keep advertising on Google and Facebook, that will continue to fund the AI/LLM/DC capex boondoggle.

With cheaper energy and lower commercial real estate borrowing costs, construction could comes back. That would mean that building materials would do well. Cement and aggregates have a particularly good industry structure of local oligopolies.

Stagflation is the big concern that we see. If the economy is weak and inflation is high, things can get very ugly. The Fed can't come to the rescue by printing. Perhaps that is what Warren Buffett is thinking about, the 1970s stagflation parallels. But it is hard to have stagflation with a plummeting oil price! Herman Kahn would probably be nodding here as the gods of the straight lines continue along.

GMO published an excellent essay recently: It’s Probably a Bubble, But There Is Plenty Else to Invest In.