The Strategy Signal Quarterly Insights – January, 2026

The Mall Experience – Where Are We Now?

For any of us who have been to a large shopping mall, especially when malls were very popular “back in the day,” a common experience was to wonder where we were in the mall relative to specific areas of the mall that interested us. We asked ourselves, “where is the food court located, where is the Foot Locker,” etc. To answer those questions, we looked for the marquee that listed all of the stores and their locations along with the very helpful “You are Here” designation. Knowing where we were in the massive mall complex helped us to get our bearings as we charted our course to visit other targeted locations.

Today, we find ourselves asking the same question about our investments – where are we now? After a volatile 2025 (thanks to the tariffs tantrum in April and subsequent market recovery when the tariffs were paused), we saw a third consecutive year of double-digit returns for the major stock indexes as well as solid returns in the bond market. As we investors assess our “financial mall” location in 2026, we are looking for direction as to the best course of action and where we should go next with our investments.

Will the stock market have another good year? How about the prospects for bonds and alternative investments like private equity and private credit? Should I increase my cash position in light of all-time highs in the stock market? I’ll discuss our take on the economy and markets for 2026 in the Outlook section of this report.

Fourth Quarter and 2025 Performance Review

Continuing the strong year-to-date performance, all four major indices finished the fourth quarter with a solidly positive return. The Dow Jones Industrials outperformed the other major averages thanks to strength in financials and industrials, as that index was not as impacted by mixed tech stock performance during the quarter. For the full year, however, the Nasdaq was the best performing major index as it benefitted from the large weightings to tech stocks, followed by the S&P 500 (where tech is the largest sector). The Dow Industrials and Russell 2000 both finished the year with solid gains, but they both underperformed the Nasdaq and S&P 500. Also, the “Magnificent 7” stocks that are so closely associated with artificial intelligence spending, easily outperformed the other 493 S&P 500 stocks for the year.

• By market capitalization, large caps outperformed small caps in the fourth quarter and for the full year, thanks to strong gains in large-cap tech stocks, which were driven higher by AI enthusiasm and solid earnings growth. That said, small caps enjoyed solid returns for the fourth quarter and full year, due to falling interest rates and generally solid economic growth.
• From an investment-style standpoint, value outperformed growth in the fourth quarter as mixed tech earnings weighed on growth funds, while solid economic data and more Fed rate cuts supported more cyclically oriented sectors that typically dominate value funds. For the full year, tech-heavy growth solidly outperformed value, however, as strength in AI stocks pushed growth styles higher on a full-year basis

• On a sector level, performance in the fourth quarter was mixed, as eight of the 11 S&P 500 sectors finished the fourth quarter with a positive return. However, for the second straight year, all 11 sectors ended the full year with gains. The healthcare sector was, by far, the best performer in the fourth quarter thanks generally to investors rotating towards more value-oriented sectors of the market, but also because fears that the prolonged government shutdown would lead to reduced federal healthcare spending went unfulfilled, and that boosted the outlook for healthcare stocks going forward. For the full year, technology and communication services sectors were the top performers, as both sectors benefitted from the substantial gains of AI-linked tech stocks.
  
  Looking at sector laggards, utilities and real estate finished the fourth quarter with marginally negative returns. Utilities were pressured tangentially by a mild deterioration in sentiment towards the AI data center boom. Real estate, meanwhile, saw modest weakness thanks to lingering concerns about home affordability and after longer-dated Treasury yields rose to multi-month highs on concerns a “too dovish” Fed chair could reignite inflation in 2026. For the full year, consumer staples and real estate were the relative laggards, as generally speaking, investors preferred exposure to more AI and cyclical sectors given high AI enthusiasm and stable economic growth. More specifically, real estate faced year-long headwinds from higher interest rates while consumer staples stocks were negatively impacted by higher tariffs.

• Foreign markets outperformed the S&P 500 in the fourth quarter and, for the first time since 2017, outperformed the S&P 500 for the full year. Foreign developed markets and emerging markets posted nearly identical returns in the fourth quarter thanks to solid economic growth in Europe and China and on expectations for rate cuts in the United Kingdom. For the full year,however, emerging markets slightly outperformed foreign developed markets thanks to falling global interest rates and a resilient Chinese economy.
• Commodities saw mixed performance in the fourth quarter that largely mirrored the performance for 2025. Gold finished the fourth quarter and year with substantial gains. A weaker U.S. dollar, rising geopolitical tensions, stubbornly firm inflation and concerns about central bank independence all contributed to gold hitting a new all-time high in 2025 and turning in the best annual performance since 1979. Oil prices, meanwhile, declined sharply in the fourth quarter, which caused oil to post a negative annual return for 2025. Despite elevated geopolitical tensions, concerns about global oversupply of oil weighed on prices throughout 2025 and made it one of the few major assets to post a negative return for the year.
• Switching to fixed income markets, the leading benchmark for bonds (Bloomberg U.S. Aggregate Bond Index) realized a solidly positive return for the fourth quarter and that helped to round out a strong year of performance for the fixed income markets.
  • Looking deeper into fixed income, both long- and short-duration debt posted modestly positive returns in the fourth quarter, but longer-duration debt outperformed thanks to better-than-expected inflation readings and as concerns about the U.S. fiscal situation continued to recede. On a full-year basis, longer-duration bonds handily outperformed shorter-duration debt thanks to declining concerns about U.S. fiscal ratios, solidly positive U.S. economic growth, and still-robust foreign demand for longer-term U.S. debt.
  • Turning to the corporate bond market, high-yield bonds outperformed higher-quality but lower-yielding investment grade debt in the fourth quarter and for the full year as solid economic data and more Fed rate cuts prompted investors to reach for higher yield amidst a stable economy and expected earnings growth.

What actions did we take in McKinley Carter portfolios last quarter?

• In our fixed income portfolios, we maintained our exposure to high yield and nontraditional bonds as well as a shorter-than-benchmark duration to lessen long-term interest rate risk and associated volatility.
  In our ActiveTrack, Earnings Focus, and Hybrid models, we added the iShares U.S. Equity Factor Rotation Active ETF (DYNF), the iShares U.S. Thematic Rotation Active ETF (THRO), and the First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index ETF (GRID) to our Tactical sleeve. We also added the Dimensional International Core Equity Market ETF (DFAI) and the Dimensional Emerging Core Equity Market ETF (DFAE) to our International sleeve and increased our international stock exposure from 30 to 35% of total equities by replacing the global Vanguard Total World Stock Index Fund ETF Shares (VT) with additional pure international exposure.
• In our Earnings Focus and Hybrid models, we removed Adobe Inc. (ADBE) and added General Dynamics Corporation (GD), a leading company in the defense industry and maker of Gulfstream business jets. We also replaced the Vanguard Energy Index Fund ETF Shares (VDE) with the Global X Artificial Intelligence & Technology ETF (AIQ) to further diversify our holdings related to artificial intelligence.
• We approved the 2026 asset allocations for our Strategic Focus models.
• For our Qualified Purchaser clients (at least $5 million in investments, exclusive of primary residence and business property), we made available offerings of stock of private companies such as SpaceX and other pre-IPO companies through the use of Special Purpose Vehicles (SPVs).

Outlook - a look ahead to the first quarter of 2026

The Financial Mall

Just as we need to know where we are in the shopping mall of financial markets in 2026 by looking for the “You are Here” signage, we also need to ask ourselves which stores (Equities, Bonds, or Alternatives) have the most desirable products and which stores have overpriced items that should be avoided.

First, let’s discuss where we are in the mall and how we got there. This will help us to assess where we should shop next or whether we should exit the mall altogether.

You are Here

Market sentiment, as measured by the CNN Fear and Greed Index, a composite of seven different indicators of current investor behavior, sits at a neutral 51, indicating that investors are neither too bullish nor too bearish on the markets. The Fear & Greed Index is a way to gauge stock market movements and whether stocks are fairly priced. The theory is based on the logic that excessive fear tends to drive down share prices, and too much greed tends to have the opposite effect. The lack of enthusiasm for the markets is a good sign in the face of markets that have reached all-time highs.

CNN Fear & Greed Index

Equity markets begin the new year riding an impressive three-year winning streak that’s been powered by rate cuts, solid economic growth and extreme investor enthusiasm over artificial intelligence, and those positive factors remain in place as we begin 2026. Perhaps one of the biggest surprises of 2025 was that continued geopolitical tensions and trade policy volatility did not negatively impact markets. But the reality is that both geopolitics and trade policy volatility are still potential negative influences on risk assets. An expansion of Russia’s war with Ukraine, a military confrontation between the U.S. and Venezuela, the July 1st review of the USMCA trade agreement with Canada and Mexico, the Supreme Court invalidating the 2025 tariffs, and the upcoming midterm elections are just some of the geopolitical and policy unknowns we must monitor in 2026, as each has the potential to cause surprise volatility.

Despite major shifts in global trade policy and the longest government shutdown in U.S. history, the economy starts the new year on solid footing. Major economic metrics regarding consumer spending, service sector demand, and business investment are showing solid growth and that is important support for risks assets as we begin 2026. Upper income consumers continue to lead retail spending as they are the beneficiaries of a “K” shaped economy where those that have higher incomes and investment assets are doing quite well while lower income consumers are struggling. High-net-worth individuals tend to hold larger positions in broad market indexes and individual mega-cap tech stocks, either directly or through wealth-management portfolios. By contrast, lower-income households with 401(k)s or minimal direct equity exposure benefitted far less from the tech rally or received even smaller absolute gains due to smaller portfolio balances. On a positive note, U.S. households should receive a larger than normal tax refund this year due to the tax bill that was signed into law in 2025.

It’s true that most economic metrics are showing solid growth and there are few, if any, major economic metrics warning of an economic slowdown. However, the labor market has been losing momentum for most of 2025. Broadly speaking, the labor market is in a current state of “Low Hire/Low Fire.” If layoffs start to increase in 2026, it will negatively shift the economic outlook and that would be a new, substantial headwind on stocks.

On monetary policy, the Federal Reserve has cut rates aggressively over the past year and a half, easing the headwind on the U.S. economy. And despite some uncertainty about the number of future rate cuts in 2026, investors do still expect a generally “dovish” Fed as the Fed projections show another rate cut (or two) in the new year while a new Fed chair (likely to be appointed soon, and who will take office in May) is expected to push harder for more rate cuts and generally be more dovish than current Fed Chair Powell.

Finally, investor enthusiasm for the productivity and profit-boosting potential of artificial intelligence has been the main fuel behind this remarkable three-year bull market, and as we start 2026, AI enthusiasm remains broadly in place. In fact, major U.S. tech companies remain committed to spending hundreds of billions on AI infrastructure buildout and that should continue to power broader economic growth and strong tech sector earnings growth. Support for artificial intelligence stocks and the tech sector remains generally high, but skepticism about the massive amount of money being poured into AI infrastructure is rising, and we saw that in mixed performance of tech stocks in the fourth quarter. If investor sentiment towards AI sours in 2026, that will remove a major tailwind from the tech sector and the entire market more broadly, and this is a risk that we will continue to monitor closely.

Inflation, Interest Rates, and Corporate Earnings - GPS for the Financial Mall Stores

When assessing which financial mall stores (Equities, Bonds, or Alternatives) to visit to spend our investment dollars, we believe that three guiding factors are most important to consider – inflation, interest rates, and corporate earnings. These factors are critical to our assessment of how we should allocate our investments. Analyzing these allows us to cut through extraneous “noise” in the economy and to concentrate on what the data tell us about the investment landscape.

Inflation:

Despite a modest downward trend in inflation data last year, the core CPI (2.6%) is “stuck” at levels above the Federal Reserve’s 2% target level after a recent increase. Meanwhile, tariffs are now starting to impact broader parts of the U.S. economy and while analysts generally believe tariffs will produce only a one-time price increase and not create broader inflation, that outcome remains uncertain. Inflation is expected to run moderately above the Fed’s 2% target this year but remain in the 2–3% range, with most major forecasters looking for some cooling as 2026 progresses rather than a new inflation spike. The broad theme is “sticky but drifting lower,” with tariffs and housing costs key swing factors. Analysts expect inflation trends to directly influence Federal Reserve behavior, and thus market direction.

Interest rates:

As growth in employment slowed markedly in recent months, the Federal Reserve lowered the Fed Funds rate by 0.25% in September, October, and December. With inflation data remaining above the Fed’s target of 2%, slowing jobs growth and weak consumer confidence are the motivating factors for the Fed in reducing rates further this year.

Recent Federal Reserve signals suggest the potential for two rate cuts in 2026, helping to explain market optimism even as economic data give mixed signals. Historically, Fed rate cuts bode well for stock and bond prices if the economy is on sound footing.

With the 2-yr. and 10-yr. Treasury bond yields (as well as the 30-yr. mortgage rates) having come down, current interest rates are supportive of stock prices. For fixed income investments, we prefer bonds that are intermediate in length (4-6 yrs.) as they still represent attractive yields with less principal volatility than longer bonds in the event of rising long-term rates in 2026.

Midterm election years have a rhythm that fixed income investors should recognize. While at first glance yields may seem unpredictable, a closer look reveals a pattern in how they behave throughout these periods. Historical data shows a clear tendency for 10-year Treasury yields to rise during the first half of the year and decline in the second half. This trend has persisted across multiple decades and various economic environments.

During election season, campaigns often promote policy initiatives aimed at driving economic growth. That narrative tends to shape investor expectations, creating a belief that stronger growth will follow. Historically, this belief correlates with higher interest rates as markets price in future economic expansion. In the second half of the year, the tone shifts. Midterm elections frequently result in the majority party losing control of Congress, which introduces legislative gridlock. Gridlock effectively removes the prospect of major growth-oriented policies, reduces fiscal stimulus concerns, and limits the ability to implement significant initiatives. The result is a backdrop that favors lower yields as uncertainty fades and expectations for aggressive policy action diminish.

If historical patterns hold, 2026 could present an opportunity for bond investors. A first-half rise followed by a second-half decline suggests that extending duration later in the year may be advantageous. While no cycle is guaranteed to be repeated perfectly, the persistence of this trend, even after adjusting for years of extreme policy intervention, strengthens the case for strategic positioning. For fixed income portfolios, midterm years often reward patience and timing. This pattern has held through inflationary periods, low-rate environments, and different fiscal backdrops. Even after excluding years dominated by aggressive Federal Reserve actions, it suggests that election-driven dynamics exert a meaningful influence on the yield curve.

Earnings:

2025 earnings for the S&P 500 consistently exceeded expectations through the first three quarters of the year. While the 4th quarter earnings reports have just begun, it is certainly possible that the pattern of better-than-expected earnings will repeat for the quarter, as earnings revisions for Q4 have been positive for all asset classes. If this is the case, and forward guidance is increased, stock prices are likely to react favorably. As earnings expectations for large cap, small cap, and international stocks are high for 2026, any disappointments may lead to harsh pullbacks in equities from their current elevated levels.

Additionally, U.S. companies’ profit margins lead the world despite tariff concerns. We continue to monitor earnings estimates changes and will adjust our outlook if conditions warrant, but for now, we see no evidence that earnings projections for this year are deteriorating. Profit margins for international companies continue to move upward as well.

Better valuations and a weaker U.S. dollar should benefit the performance of foreign stocks as they did in 2025.

Conclusion

The Financial Mall Stores – Where should we shop?

Equities store (prices are still reasonable for many items):

Inflation data, interest rates, and earnings are all supportive of an overweight position in stocks. The factors that have fueled this three-year bull market remain in place as we start the new year and that means the outlook for stock markets and risk assets remains positive. Productivity through AI enhancements, deregulation, tax cuts, and deductions for corporate capital spending are all positives for U.S. companies. Additionally, the broadening out (better performance by non-tech, international, and smaller cap stocks) in market participation that we have seen recently is a healthy sign for continued gains.

However, that positive outlook should not be confused as being one without risks. And while the outlook is positive, it is also fair to say the equities market enters 2026 with weaker tailwinds than it’s had in the past few years. AI investment fatigue, another possible government shutdown, tariffs impact on inflation and earnings, Federal Reserve rate decisions (and a new Fed chair in May), a July 1st review of the USMCA trade agreement between the U.S., Mexico, and Canada, geopolitical conflicts, and midterm U.S. elections are all events that could shake investor confidence if perceived negatively.

Bonds store (still good for income buyers, but look for bargains if longer bonds go on sale):

Inflation data and interest rates are still supportive of bonds in terms of income streams. However, we’re unlikely to see the total return gains of 2025.

Alternatives Store (a good place to shop for specialty items):

Inflation data, interest rates, and earnings are supportive of investments in alternatives like private equity, hedge funds, and private credit. Also, healthy GDP numbers support more companies coming to the public markets from the private markets as private market valuations increase. Alternative investments can also help to mitigate portfolio risk through lower correlations with public stocks and bonds and an increased tax efficiency through the use of options and other strategies such as direct indexing. Select infrastructure investments are also good portfolio diversifiers as aging infrastructure systems such as power grids are repaired or replaced.