The Broadening Will Continue Until Morale Improves

Macro

The US economy remains resilient. The Atlanta Federal Reserve (Fed’s) GDPNow model as of January 26 shows 4.2% growth in real gross domestic product (GDP) for the fourth quarter (Q4) of 2025. Note that this model is noisy, and the number can and does change quickly.
Our US real GDP forecast for 2026 is 2.5% (based on our Global Investment Management Survey), versus the Fed's forecast of 2.3% and the Wall Street consensus of around 2%. The main drivers of our GDP forecast are the continued capital expenditure (capex) spending by big technology firms (Meta recently reported plans for even higher investments), a resilient consumer (as Royal Caribbean recently reported and large banks reported roughly two weeks ago) and the likely impact of higher tax refunds this year, which estimates suggest may be run US$100 billion‒US$150 billion above 2025 (source: Strategas).
We expect the Fed to cut rates twice in 2026 and core Personal Consumption Expenditures to remain stable in the 2.5%‒3.0% range. Fed policymakers are more concerned with the employment picture than they are with inflation. They should be. The U-3 unemployment rate was 4.4% as of December, the highest level since October of 2021. Fed Chair Powell’s comments at the January 28-29 policy meeting suggest the Fed is in no hurry to cut interest rates, and the risks to its dual mandate are more “balanced” today compared with a few months ago. Time will tell.
Kevin Warsh is US President Trump’s nominee to be the next Fed chair. Warsh was on the Fed’s Board of Governors from 2006 to 2011. He is currently an advisor to Stanley Druckenmiller’s Duquesne Family Office. Warsh seems inclined to believe in lower policy rates as well as working on the Fed’s balance sheet.
Inflation expectations shot up this week. One-year breakeven rates are currently 3.31%, up from 2.80% a few weeks ago and significantly higher than in mid-December, when they were about 2.25%. This move could be a reaction to rising oil/commodity prices. Two-year breakeven rates are 2.81%, up from 2.54% a few weeks ago. Five-year breakeven rates are 2.55%, up 15 basis points (bps) over the last few weeks. These numbers represent bond market pricing of annualized inflation expected in the coming one, two and five years. This trend is concerning in the near term.
On the currency front, our survey sees the US dollar essentially flat in 2026, despite a 3.5% decline over the last eight trading days. The dollar is now back to the lows of 2025.

Equities

We are constructive on US equities and have established a target range of 7,000 to 7,400 for the S&P 500, with likely 8%‒13% year-on-year (y/y) earnings-per-share (EPS) growth to play a key role in driving stocks.
History shows stocks follow earnings over time. In the US market, the strongest cumulative growth in earnings power for 2026 and 2027 appears to be in the small- cap arena, with earnings growth for small growth companies estimated to be +116%, for small core, +95%, and for small value, +84%. We continue to find it an attractive time for increasing exposure to small caps. This is not a new call. We have been bullish on small caps since January of 2025.
At the same time, forward cumulative earnings growth appears robust across the board. Looking across capitalization size, investment style and indexes, cumulative earnings growth rates range from +24% to +116% (source: Bloomberg). Everything appears to participate. Equity portfolios can position for this broad earnings power through broad and diverse equity exposure across company size and investment style.
We observe the same phenomenon when looking at the S&P 500 Global Industry Classification (GIC) sectors. Forward two-year earnings growth rates range from +15% to +43%, led by the information technology sector (source: Bloomberg). Note that every sector shows likely growth.
Broad earnings power is evident outside the United States as well. The cumulative growth forecasts for 2026 through 2027 are strong, with emerging markets leading at +33%, Europe at +24% and Japan at +21%. It is an attractive time to have exposure outside the United States if that is a part of your allocation.
We believe the conclusion is straight-forward: It is time to consider a diversified equity playbook that includes US large-, mid- and small-cap exposure, with a balance of growth and value. The same can be said if ex-US equity exposure is part of your strategy—we consider it an attractive time to own emerging markets and developed international markets. We believe earnings trends today suggest it is best to avoid narrow concentration and spread equity investments more broadly. We have just produced a research paper supporting our outlook, “Broadening momentum: From US technology leadership to US small caps and emerging markets.”
Some of you have asked me if I think the small cap move is just the “January Effect,” referring to a seasonal pattern for stocks, especially small caps, to perform well in the first month of the year. Fair question. Let’s look at the data: In the trailing 12-month period (January 29, 2025 to January 29, 2026), the Russell 2000 Index is up 17.52% vs. 16.23% for the S&P 500 and 21.99% for the Magnificent Seven (Mag 7) basket (the stocks of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla). Small caps have been outperforming the S&P 500 for the past year. This is not the “January Effect.” Similarly, from the April 7, 2025 lows, the Russell 2000 is up 47.78% vs. 38.62% for the S&P 500. This is broad participation, it’s not a recent phenomenon, and we expect it to carry through for all of 2026 with bursts of rotation.
I recently recorded a podcast with Kate Lakin, Director of Research and Portfolio Manager at Putnam Investments. We discussed the equity market and what to expect going forward. Have a listen to our discussion.

Fixed income

We expect US 10-year Treasury bond yields to trade in a range of 4.0%‒4.25% in 2026. The market is currently at the upper end of that range, at 4.23%. The two-year yield has been range-bound for the last few months as well, and the US yield curve has steepened modestly, with the 10-year–two-year spread at 67 bps. We expect more bull steepening in 2026.
We expect short duration fixed income mandates and corporate credit will likely perform better than cash again this year. Considering our views on US 10-year Treasury yields, we do not expect duration to be a significant driver of total return this year. Rather, all-in yield capture seems to be the play.
Despite fears of a looming credit crisis, we see little evidence of that in corporate bond spreads. Investment-grade spreads (one-year to three-year option-adjusted spreads, or OAS) are 44 bps over Treasuries. High-yield (HY) spreads, as proxied by the Bloomberg US Corporate High Yield Index OAS, are 259 bps over Treasuries. Both measures are very close to five-year tights. These indicators suggest corporate fundamentals remain healthy. Significant spread compression from here seems unlikely to us, in either IG or HY space.
We are bullish on municipal bonds again this year and find taxable equivalent yields to be attractive along with robust fundamentals. Importantly, the increased supply in the muni marketplace appears to have run its course for now, and muni bonds have been performing well since last August. We think this steady performance is likely to continue.
Please see our recent white paper, “Municipal bonds are back” by Richard Polsinello and Lukasz ⁠Labedzki. This paper captures the opportunity in municipal bonds, in our opinion.

Sentiment

The percentage of bullish investors in the latest AAII Investor Sentiment survey is 44.4%, which is up from the 19.3% reading in March of 2025. The percentage of bearish investors in the AAII survey is 30.8%, which is down from the 62% reading in the first week of April 2025.

We will continue to analyze the markets and will offer insights again next week.

Source of data (except where noted) is Bloomberg as of January 30, 2026. There is no assurance that any forecast, projection or estimate will be realized. An investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. Important data provider notices and terms available at www.franklintempletondatasources.com.

The Franklin Templeton Institute Global Investment Management Survey is a biannual outlook survey designed to give a view across our investment teams. The Franklin Templeton Institute identifies the median across the survey answers and develops the outlook. The survey received responses from around 200 portfolio managers, directors of research and chief investment officers, representing participation across equity, private equity, fixed income, private debt, real estate, digital assets, hedge funds and secondary private markets. Each of our investment teams is independent and has its own views.

Glossary of terms

The AAII (American Association of Individual Investors) Sentiment Survey offers insight into the opinions of individual investors by asking them their thoughts on where the market is heading in the next six months.

Breakeven rates: The difference between yields of Treasury bonds and TIPS for issues of the same tenor/maturity, calculated by subtracting TIPS yields from Treasuries; a measure of inflation.

Capital expenditure (capex): Funds that companies spend to acquire, upgrade or maintain physical assets, such as buildings, technology or equipment, with the purpose of maintaining or growing future operations.

Duration: A measure of how much a bond’s price changes relative to changes in interest rates.

Earnings per share (EPS): A company’s earnings divided by its outstanding shares of stock.

GDPNow: A running estimate of real GDP growth based on available economic data for the current measured quarter; not an official forecast of the Atlanta Federal Reserve Bank.

Option-adjusted spread (OAS): Measures the spread between a bond's interest rate and the risk-free rate, while adjusting for any embedded options like callables or mortgage-backed securities.

Personal Consumption Expenditures (PCE) and core PCE: Measures the price changes in goods and services purchased by US households; core PCE excludes food and energy prices. Both are measures of inflation.

Price-earnings multiple: A ratio calculated by dividing a company’s share price by its earnings per share, a measure of valuation.

Taxable equivalent yield: The yield of a municipal bond investment calculated to reflect the benefits of income tax exemption and to be comparable to the yield of a taxable bond.

U-3 unemployment rate: The official measure used by the US Bureau of Labor Statistics (BLS) to report the percentage of the labor force that is unemployed and actively seeking work.

Yield spreads/tights: Spreads are the difference between yields on differing debt instruments of varying maturities, credit ratings, issuers or risk levels. “Tight” in reference to spreads indicates small differences in yields.

Indexes

Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator of future results.

Bloomberg US Corporate High Yield Index: Tracks the performance of the USD-denominated, high yield, fixed-rate corporate bond market.

S&P 500® Index (SPX): A market-capitalization-weighted index of 500 stocks, a measure of broad US equity market performance.

Russell 1000® Index: A market-capitalization-weighted that measures the performance of the 1,000 largest companies in the Russell 3000® Index, which represents the majority of total US market capitalization.

Russell 2000® Index: A market-capitalization-weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000 Index.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce desired results.

Diversification does not guarantee a profit or protect against a loss.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The investment style may become out of favor, which may have a negative impact on performance.

Large-capitalization companies may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

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