Mike Wilson: What 2026 Has In Store For Markets

Thank you. Lucky 13. I guess he might as well be a co-host.

Well, it's a new year and, as they say, a new start. But I don't view the calendar year as being any magical thing. I think other people say the same. But I do think it's kind of a continuation of what we've been seeing, which is that the market figured out last year, I think rightly, that we sort of had all the bad stuff up front and then they cleared the decks and they gassed it even more than probably most people expected, including us, and that was our call. The market is kind of on board with that. The question now is has the market gotten ahead of the reality of what I think 2026 is going to bring or what risks are they missing? One risk that I think they've taken care of, which is a good thing, is that in the fall, the last time I was on here we were talking about this liquidity tightening and that was causing a lot of problems, quite frankly, with some of the speculative names like the quantum computing or some of these real high flyers. They got whacked, including crypto. And the Fed, to my surprise, got ahead of it for the first time where they ended QT early and then in December, I think, surprised the world with starting asset purchases again in a pretty meaningful way. I don't know anybody who had that call that they were going to start $40 billion a month on whatever mid-December. So that alleviated some of that risk in the funding markets. So that's all good. One caveat though is that crypto hasn't really rebounded. So the really liquidity-sensitive assets haven't really snapped back in a way that I would have thought they would have if that was truly a surprise or the Fed was doing more liquidity than the market needed. So what that tells me is the Fed's doing just enough. They're not doing excess money printing or asset purchases. So that's fine. It means the stocks, it's going to be more about being in the right places as opposed to the tide lifting all boats, at least in the near term.

Well, there's two things I would say. I think Jay Powell's done a fine job. I don't think he's been better or worse than... This is a tough job, as I said this morning, and everybody likes to be the Monday morning quarterback and say, 'Oh, I should have done this, should have done that.' The reality is that I think he steered it probably as well as he could have. He made some mistakes, obviously, did some good things. I will tell you this: we don't change Fed chairs that frequently, and I don't care who it is, there's always a honeymoon period. So 'be careful what you wish for' is that the markets are going to have to adjust and test themselves now to this new person, whoever it is, how they communicate with the market, their first presser. The markets test them, they punish, they push them around a little bit. So I do think no matter who the next Fed chair is, it's going to create more volatility because the market just doesn't know how to deal with this person yet.

Yeah. No, I think first of all, I don't think that market test is going to happen until the person's actually in the seat. So even if they announce somebody new and they get approved or confirmed, I don't think the market's going to start testing until that first presser, which is June or May. So we have a little time on the clock. I think more importantly, the real question is does a new Fed chair change my fundamental analysis? Not really, because I think whoever's in the seat is going to end up kind of doing the same thing depending on what the demands are. And I would say the demands on the Fed, my order of operations is different than most people. Most people would say inflation first, jobs second, and then financial conditions third. I think it's the other way around. I think it's funding the deficit, helping the Treasury fund the deficit. That's job one and has been job one for quite a while. Then it's probably jobs, and then probably inflation at the bottom.

Well, prior to the... there was an agreement in the early 50s where they basically separated the posts. Prior to that, the Fed and Treasury did work much more hand in glove. So you're just going back to the way things were prior to that. Now, let's not kid ourselves. They've drifted already, probably starting 20, 30 years ago where the Fed and Treasury have been working more closely together, and it's just not as transparent. So I think probably what Treasury Secretary Bessent has been saying is let's just be honest about it. This is what we're doing. We are going to work together to help fund this massive deficit that we together built over the last 30, 40 years, and we got to figure out how to deal with it, and we need to be flexible and be willing to try new things to do that.

They are. And look, they're issuing even more bills now as a percentage of the total. They're just starving the market of duration. Some people call this Treasury QE. It's interesting, and I've seen estimates from some people who I think are credible saying that this has amounted to maybe as much as 70 to 80 basis points of yield compression at the back end by starving the market. Now what's interesting to me recently is the 30-year yield has been a little less well behaved. The spread between 30s and 10s. So if you really want to look at what's going on with the term premium and whether the bond market is getting worried, look at the 30-year spot. It's less liquid, there's not as much institutional demand for asset liability defeasance going on at the 30-year point because of the liquidity issue there. So that to me is the signal that the market may not be as comfortable as you think. It is still an issue.

100%. Because there's a natural amount of demand that's organic. It's always there. There are natural buyers of 10-year Treasury yields because they have insurance companies, pension funds, banks, whatever. People need that duration. And so if you just don't issue it there, you're going to have...

Of course, but they're not going to. There's no need to do that.

Yeah. There's no law that says they have to do a certain amount of issuance at a certain point. Now, at some point, here's the other side of the argument: what we're doing is what emerging markets do. So there's that argument. And I think the early warning sign there will be the dollar starts to really tank. Right now, the dollar seems to be okay with this. So there are things I'm looking at that are early warning signs. For equities, it's always credit spreads. For the bond market, it's probably the dollar. The 30-year maybe is a little bit of a wobble, but I don't see a lot of flashing red right now.

That would be kind of the emerging market assumption that the global markets are saying you guys are doing what countries that can't fund themselves do, which is issue the front end.

There's been a buyer strike already. I mean, China's not been buying Treasuries. Japan's been buying way fewer Treasuries because JGBs now are more attractive when unhedged. So I think we've already had that shock. It's kind of amazing, to your point, Guy, that the 10-year hasn't seen more volatility, but I think this really speaks to this idea that there's an organic, natural level of demand. We've kind of reached that equilibrium for the most part. They're not issuing a whole bunch there, and it's manageable for now. I think the bigger shock would be if we had a real shock to receipts, like the budget really blew out in a way, like a recession. Then the bond market would go, 'Oh, they're not going to be able to make it.' That's not where we are, but in the next major growth scare, a proper recession, I think you could see bond yields go up in the back end, and that would be scary. But that's not where we are right now. I worry about that outcome. Eventually, we will have one. If we don't get our house in order before then, that could be the spark. But that's not in 2026 in my view.

I think they're focused on it in the wrong way. First of all, we believe the employment market bottomed in April. We've written extensively about this. I think we've proven it out, and it's an out-of-consensus view that the rate of change on both layoffs and the revisions to the payroll numbers troughed in April, and that's why the market has moved up so sharply. So I'm not worried about the labor market at this point. We already had the recession over the last three years, and now we're seeing private employment actually improve, and government employment is coming down, which is what you want to see. It's a much more healthy, balanced economy. From an inflation standpoint, I think that sometimes equity investors misinterpret that inflation is good for stocks. Deflation is the worst thing imaginable for stocks. Inflation is only bad for stocks when the Fed has to react to it. So right now we're in that sweet spot where inflation is probably above target, 2.5 to 3%, and it's probably not going to go below 2% anytime soon. In fact, it may reaccelerate with all this stimulus. That's fine so long as the Fed isn't raising rates or tightening. I think we have a year at least, maybe a little less, to say that the Fed is going to turn a blind eye to inflation because they kind of want some inflation. Once again, that's the third most important thing. They need inflation to grow out of the debt problem.

No. And by the way, it's kind of flat since Liberation Day. And don't forget, post the trough of a recession, typically the unemployment rate goes up for one to two years after, and it's really bullish for the stock market because what that means is that you're seeing a recovery and companies are not hiring. Margins improve. So that's what we have right now, this interesting setup where you have no hiring, no firing. There's not a lot of firing going on, but there's no hiring going on.

And again, none of those expectations or the way you're thinking about that has to do with productivity gains from AI. I mean, it really is kind of...

Well, what I would tell you is we're modeling in 40 basis points for AI. I mean, it's so hard to be that specific, but that's what we're modeling. And what I would say is that I don't see a wide, broad example of AI really impacting margins. What I see though is the threat of AI is impacting the behavior of corporations. So in other words, what corporations are doing, white collar, not blue collar, white collar businesses are doing the following. Business is picking up, and they're saying, 'You know what, this AI thing may be a problem. Let's not rush to hire a bunch of people.' So we're getting revenue increases, but companies are telling their current employees, 'You're going to have to do more.' And the tools they're given can help them be more productive. But let's be honest, Dan, it's not really happening yet.

We are absolutely using AI for a lot of the textural stuff, a lot of learning. So we can aggregate data, we can aggregate a lot of information and summarize it so we can learn about things more quickly. That's where it's extremely good. Where it's not good yet at all is computational. So we can't use it to do our modeling. We can't use it to crunch a bunch of numbers and spit them out in a way where I can trust it. I still need real humans doing that in a way where it's reliable. But I think we'll get there.

Yeah, it does. I think it's going to be like every technology platform. There is a learning curve, and usually the younger people are faster than guys like me, and they're embracing it, and we're seeing different speeds. Here's the dichotomy. It's the large corporations that have the resources to deploy this stuff broadly, but it's the smaller corporations, the more entrepreneurial corporations, that have the willingness, ability, guts, whatever you want to call it, to really use it more aggressively. So there's going to be a collision there. And what usually happens is some smart developer comes along and creates applications for dummies like me that are compliant as well. And that allows the full diffusion of the technology broadly into the economy. But this is why stocks are expensive. One of the reasons, not the only reason. There are two main reasons. One is inflation. So you should be willing to accept a lower equity risk premium if you think inflation is your biggest risk over the next 10 years, which I think it is and I think most people agree with that. The second one is that the market is imputing some productivity benefit, margin expansion, that it has bought into this diffusion of this AI technology already. So you've priced some of that. Who knows what the path looks like? But I think we're seeing enough evidence now that suggests that that's the right bet.

So that's without probably the full incorporation of AI, to exactly your point. So you could actually see continued improvement on the productivity side without question. There's a lot of weird things going on. We're still in the post-COVID world. We have all these aberrations, and of course immigration I think is a huge impact. Let's talk about what productivity is. I was just talking to our chief economist about this today. It's a plug. It's a residual. It's basically you calculate GDP, you calculate the labor input, and then productivity spits out over here. So what's been going on? Well, GDP has been kind of a weird thing because of all the tariffs and exports and imports and how that affects the calculation. We've got a boost this year in GDP because now exports are up and imports are down. That's a one-time adjustment. Then you have the labor adjustment from immigration. So basically, less people coming in, deportations, less labor supply, less availability of labor. So people aren't hiring as many people for two reasons. A, people aren't available. And number two, because of the AI threat, labor in the short term has been suppressed. Higher GDP, lower labor, better productivity. The question is, is that real? Is it sustainable? It's definitely real. It's a cyclical uptick. We don't know yet. It's lumpy. I truly believe that we will have higher productivity over the next 10 years for two reasons. A, we've underinvested in literally everything. And secondly, now we have the incentives in the tax bill to pull that forward and actually start doing some of that. So I think productivity is going to be higher. Trend line over the long term is 1.5%, and it oscillates around that. Today we're running on a trend line basis closer to 2%. The boom in the 90s was 2.5%. So that's your upside, 2.5%. So we're kind of in between the maximum and trend line. I don't think it's crazy where we are right now. I think that's about right.

In some people's minds.

Not my mind.