Wall Street posts three-week losing streak as Iran war batters sentiment
The S&P 500 finished December with a modest loss of 0.05% (not including dividends), breaking its 7-month win streak that began back in May. Total price return for the index for 2025 came to 16.39%, which is above the historical average of 9.16% since 1958, but slightly below the average for positive years (+16.96%).
That makes three straight years of double-digit positive returns. Over the last 68 years, there has only been one instance where the S&P 500 experienced 4 straight years of double-digit returns (1995-1999). Doesn’t mean it can’t happen again, but it’s been quite rare. It would be a good idea for investors to temper their expectations for 2026.
Which brings me to my next point. According to the 4-year presidential cycle, the next few quarters are notably weak and volatile on average. The average price return for the S&P 500 since 1958 is 9.16%, but the average price return for midterm years is just a paltry 1.38%. Q1 & Q2 have finished positive only 35% and 41% respectively. While Q2 & Q3 have been the weakest quarters on average.
Add to the fact that we enter 2026 with valuations as high as they have been in many years. The forward PE of 23x is about 34% above the historical average, as well as 13.7% & 21.5% above its 5 and 10 year average.
And stocks are even more expensive when compared to bonds. The equity risk premium (S&P 500 earnings yield minus 10-year bond yield) is essentially 0%, as depicted by the above chart. The last time we had PE multiples this high was during the COVID shutdown. The difference is that back then, interest rates were around 1%, thereby stocks still looked reasonably attractive in comparison to bonds. That is no longer the case today.
So we have a record win streak, entering tough seasonality, amid high valuations. Doesn’t mean we can’t have another good year, but investors should manage expectations and not be surprised if we start off shaky.
Now onto better news. Earnings are expected to grow about 15% in 2026, and if companies continue beating expectations at a similar pace as they did in 2025, final growth results could end being in 20%+ range. Over the last few weeks, 12 megacap S&P 500 companies reported results, with all 12 beating EPS estimates by an average of 11.9%, while 75% beat sales estimates by an average of 2.0%.
Q3 results were stellar, and in a couple of weeks, we will begin to get Q4 results. Right now, estimates are about 8-9% growth for Q4, and depending on the beat rate, that final result climb to around 15%.
Stock market returns are essentially a function of earnings and interest rates. Strong earnings growth bodes well, and it’s what you want to see in a bull market obviously. 2025 saw earnings grow about 12%, with Q4 results still to be reported, as the 10 year rate also declined from about 4.6% to 4.1%. Lower rates mean those earnings are worth more. Especially critical at a time when valuations are quite high.
In 2026, I believe rates will be the most important component that will determine how stocks ultimately perform. If we get enough rate cuts to keep the longer end of the curve trending lower, then I think current high multiples could still hold serve. But if rates push higher, especially if we get a break above the 2025 high in the 10-year (around 4.8%), I can’t envision a scenario where the stock market will be able to shrug that off, at least in the short term.
More good news, the technicals and market internals are still looking pretty solid. No bearish divergences that I can spot yet, when it comes to the major averages (including small caps and equal-weighted S&P 500), while the advance-decline lines still look pretty good overall.
Bottom line: There are reasons to be optimistic, and there are reasons to be cautious. It all comes down to your investment time frame. My single most important theme for 2026 will be how interest rates perform. And if they can hold these well above average valuations.
Q4 earnings reports won’t really begin for a couple of weeks. But next week we’ll get many key economic reports for December, including the employment reports and ISM manufacturing & services PMI’s. With the extended shutdown, we’ve been in the dark on some of the key economic indicators. Heading into 2026, we should begin to get a better picture of where the economy stands.