February 2026: Rotation Broadens as Policy Noise Rises

Newsletter — February 2026

Dear Clients and Friends,

As we enter February 2026, the global economy is navigating a unique "multidimensional polarization." The exuberant AI-driven rallies of the past two years are meeting a cooling labor market and a shifting geopolitical landscape. While the "Santa Claus Rally" extended into the first weeks of January, pushing the Dow Jones Industrial Average above the 49,000 mark for the first time—investors are now grappling with a more complex set of variables. At this point, there is much better overall visibility for the first half of the year than the end of the year.

The current investment backdrop is one of slowing but still resilient growth, sticky inflation, and renewed geopolitical and tariff uncertainty that has already jolted markets in January. Equity and bond markets are oscillating between optimism about earnings, rate cuts, a potential “AI bubble” and concern that policy shocks and higher-for-longer inflation could compress valuations from elevated starting points.

1. The Economy: Resilient Growth, Cooling Labor

The U.S. economy continues to defy the "hard landing" skeptics, though the pace of expansion is moderating.

• GDP & Productivity: Most forecasts project 2026 growth between 2.2% and 2.5%. Interestingly, this growth is being driven more by productivity gains—likely the first real "AI dividend"—than by labor expansion.
  
• The Labor Market: This remains the most uncertain piece of the puzzle. December’s jobs report showed a modest gain of only 50,000 jobs, significantly lower than the 2024 average. With federal job cuts and a decline in immigration, the economy is entering a period of "jobless growth."
  
• Inflation: Core PCE (the Fed’s preferred gauge) remains sticky around 2.8%. While tariff-related costs contributed roughly 0.5 percentage points to this figure, underlying inflation is showing signs of stabilizing toward the 2% target as supply chain pressures ease.

2. Monetary Policy: A "Data-Dependent" Pause

The Federal Reserve, led by Chair Jerome Powell (whose term expires this May), appears to be shifting into a "wait-and-see" mode. The Fed cut rates three times in late 2025 but is widely expected to be more cautious in 2026 given sticky core inflation and still-resilient spending data. Central-bank surveys and private-sector research suggest that while additional easing is likely over the next few years, the pace of cuts should slow meaningfully in 2026

• Interest Rates: After a 25-basis-point cut in December to 3.50%–3.75%, the Fed is expected to hold steady in the near term. Markets are currently pricing in only one or two additional cuts for the entirety of 2026.
• The Independence Debate: Recent political investigations into the Fed have raised eyebrows, yet market reaction remains muted. Investors seem to have "priced in" the political noise, focusing instead on the Fed’s pivot from fighting inflation to supporting the cooling labor market.

3. Market Performance: Rotation is the Theme

January saw a notable shift in leadership. While the "Magnificent Seven" dominated 2024 and 2025, we are now seeing a broadening of the rally. This is a very healthy development, in my opinion.

• Sector Winners: Health Care and Financials led the charge in the most recent quarter. Lower short-term rates have improved bank profitability, while the "AI trade" is rotating into second-order beneficiaries—industries like defense and utilities that provide the infrastructure and security for the tech boom.
• International Resilience: International and Emerging Markets outperformed U.S. large-caps in late 2025/early 2026. A weaker U.S. dollar and attractive valuations in Europe and Japan are drawing capital away from the concentrated U.S. tech sector.
• Real Assets: Gold and Silver have "shined" recently, driven by central bank purchases and a flight to safety amid geopolitical tensions in South America and the Middle East.

4. Key Risks to Watch

As we move into the second month of the year, keep a close eye on:

1. Geopolitical Friction: The U.S. pivot toward the "Monroe Doctrine" and operations in Venezuela have introduced new volatility, though energy markets have remained surprisingly stable due to robust global supply.

2. The "AI Bubble" Debate: As companies shift from "investing" in AI to "monetizing" it, the market will demand proof of earnings. Any disappointment in the Q1 earnings season could trigger a revaluation of tech premiums.

3. Fiscal Cliff: The temporary spending bill is set to expire soon. Any disruption in government funding could impact the recent momentum in defense and infrastructure sectors.

Bottom Line: While "easy money" of the broad index rally may be behind us. 2026 is shaping up to be a year for active management, where success is found in diversification across value stocks, mid-caps, and international markets.

PRIOR

Macro growth and inflation

Global growth is holding up better than feared, with forecasts for real world economic growth around 3.1–3.2% through 2027, suggesting a slowdown rather than a collapse. At the same time, global risk surveys show a rise in concerns about an economic downturn, inflation, and potential asset bubbles as central banks navigate what may be perceived as a late-cycle environment.

In the US, headline and core inflation have drifted down from the post-pandemic peaks but appear to be plateauing above the Fed’s 2% target, with recent readings around 2.7–2.8% and several forecasters expecting inflation to remain somewhat “sticky” throughout 2026. This “3% is the new 2%” debate is central to the policy outlook, as a slightly higher equilibrium inflation rate might justify policy rates staying restrictive for longer than markets became accustomed to in the prior decade. The current consensus, however, is that we will likely get one or two rate cuts this year.

Labor market and real economy

The US labor market has cooled from its earlier boom but remains in what analysts describe as a “low firing” environment, with weekly initial jobless claims hovering near 200,000 and continuing claims under 1.9 million.

Total job postings are only about 6% above pre-pandemic levels, but postings mentioning AI or AI-related skills are up over 130% versus 2020, emphasizing how technology is reshaping demand for labor and capital. This dynamic supports profit margins and productivity in some sectors, but it also heightens political pressure around wages, globalization, and trade, which feeds back into policy volatility and market risk premia.

Policy, geopolitics, and tariffs

The Federal Reserve cut rates three times in late 2025 but is widely expected to pause at its January 27–28 meeting given sticky core inflation and still-resilient spending data. Central-bank surveys and private-sector research suggest that while additional easing is likely over the next few years, the pace of cuts should slow meaningfully in 2026, with policy staying restrictive relative to the pre-COVID era.

Geopolitics and trade have re-emerged as front-burner risks. The Trump administration’s posture on tariffs and its high-profile dispute over plans related to Greenland triggered renewed talk of a trade confrontation with Europe in January, briefly sparking a broad

risk-off move in which equities, long-duration Treasuries, and the dollar all sold off simultaneously. Markets recovered quickly after President Trump publicly walked back the latest round of Europe-focused tariffs, catalyzing a two-day rally that recouped much of the earlier damage, but volatility rose and investors were reminded how dependent valuations are on policy headlines.

Markets: equities, rates, and credit

US equities entered 2026 after three years of double-digit gains and rich valuations, leaving the major indices vulnerable to negative surprises. A mid-January shock around tariffs saw the S&P 500 fall about 2.1% in a single session, its largest one-day decline in more than three months, before rebounding as the policy threat eased. Year-to-date, performance is mixed: as of January 20, the S&P 500 was modestly negative, the Nasdaq was down more, while the Dow and small-cap Russell 2000 were slightly positive, reflecting rotation beneath the surface.

Earnings expectations, however, remain broadly constructive, with strategists looking for a strong fourth-quarter reporting season driven by a broadening of profit growth beyond large-cap technology into cyclicals such as industrials and financials. Consensus year-end 2026 targets for the S&P 500 cluster in the 7,500–8,000 range, implying mid-teens upside from current levels if growth and margins hold up, but that upside is conditional on avoiding a more serious policy or geopolitical shock.

In fixed income, the 10-year US Treasury yield has been trading in the low-to-mid-4% range in January, reflecting a balance between expectations for future Fed cuts and concern that core inflation will remain above target. For diversified portfolios, this reset in yields improves the prospective real return from high-quality bonds, but it also means that equity valuations are now competing against a more attractive “risk-free” alternative than in the zero-rate era.

Portfolio implications and positioning themes

Against this backdrop, several themes stand out for investors heading into February:

• Emphasize quality and resilience: With elevated valuations and policy-driven volatility, balance sheets, cash-flow durability, and pricing power matter more than ever across both equities and credit.
• Diversify geopolitical and tariff exposure: Given renewed trade frictions and regional flashpoints, portfolios concentrated in a narrow group of countries, sectors, or supply chains may face idiosyncratic shocks.
• Re-underwrite inflation assumptions: If inflation settles closer to 3% than 2% in the near term, asset-allocation models that assume a low-inflation world may understate the risk of real return erosion in cash and long-duration nominal bonds.
  
• Balance growth with value and income: With earnings broadening beyond mega-cap technology and bond yields back above 4%, there is a more even playing field between growth, value, and income-oriented assets than earlier in the cycle.

As always, this environment favors disciplined risk management, thoughtful diversification, and a long-term focus—recognizing that volatility around headlines and policy decisions is a feature of the current regime rather than an exception.

We appreciate your trust and we are always here to answer your questions and discuss our outlook and its impact on your specific plan. Please do not hesitate to reach out if we can be of assistance!

Wishing you and your families a very healthy and prosperous 2026.

Sincerely,

Eric Boyce, CFA

President & CEO

Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Risks: All investments, including stocks, bonds, commodities, alternative investments and real assets, should be considered speculative in nature and could involve risk of loss. All investors are advised to fully understand all risks associated with any kind of investment they choose to make. Hypothetical or simulated performance is not indicative of future results.

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