Quarterly Edge: Q1, 2026 Investment Outlook: Are We in a Market Bubble?

Hello, I am Daniel Dusina, chief investment officer at blue Chip partners. And I’m Dan Seder, the managing partner. So just as we do at the onset of every quarter, I’m here to talk about our outlook for the first quarter of 2026 and beyond. Then where would you like to start, Daniel? It’s been an interesting year and an interesting quarter.

Why don’t we kick things off? Let’s start with the economy. We’ll gold economy first jump in the stocks and finish with bonds. But what are you seeing in the economy. Yeah I mean I won’t sugarcoat it. I’m going to spend a little bit less time than I usually would on the economic side of things. Just because the fourth quarter of 2025 was interesting from the perspective of us not being able to have accurate data, the government shutdown, it affected a lot of different things as it pertains to the market.

But one thing in particular was just the fact that we’re now kind of still flying blind from a data perspective. Whether you look at labor market data, inflation data, or a whole heap of other things that are still kind of clawing back from an availability perspective, it makes our job and the Federal Reserve’s job very challenging to make decisions or suggestions without having a complete picture.

With all that said, what I would say is that I think 2025 from an outright economic growth perspective surprised a lot of people. Case in point, we really don’t even have GDP growth figures for the third quarter. So what I’ll cite is just the second quarter being up close to 4% from an overall economic growth perspective was surprising.

Especially when you look back to all the the tariff tantrum stuff that happened, early to mid-year. What we did have was a few different things. We had a heap of AI investment that is starting to come to the come to fruition. It’s no longer just speculation and the fact that these massive levels of capital expenditures are starting to flow through the economy, I do think that continues to be a meaningful tailwind and somewhat of a floor under economic growth for the U.S for not just the first quarter of 2026, but the entirety of the year and beyond.

As well. As I look at next year from a headline GDP growth perspective, you know, I think you’re going to have reduced levels of tariff drag. There was some implications from tariffs that resulted in funkiness of data. But as we lap those figures getting into the second half of 2026, I think the runway is relatively free and clear.

Not to mention the fact that you have easier financial conditions. You’ve had a Federal Reserve that has changed the interest rate paradigm, lowering interest rates, increasing borrowing, and ultimately just making the general state of affairs from a financial conditions perspective easier. And that benefits companies. It benefits the country overall from an economic growth perspective. And so all in from a headline perspective, I think that the US does have a potential to outpace what investors are currently pricing from an economic growth perspective in 2026, the the muddier pieces of the picture are certainly on labor and inflation.

So the precipice for the Federal Reserve starting to ease financial conditions, lowering interest rates really has been the labor market. We started to see slowness in the labor market really as early as the beginning of 2025. So you’ve you started to see less jobs being added, improving productivity, but a moderately higher unemployment rate. I do think that you start to see this, this unemployment rate picture continue to move in the direction that it has been, meaning higher unemployment rate.

That doesn’t necessarily have to be cause for alarm, but just given what has been happening on the immigration front, even all the way back as far as Covid in 2020, you know, you’ve had a reshaping of the labor market. So I do think that a higher unemployment rate should be expected. But I’m not going to say that, you know, we’re going to blow past 5% on unemployment or anything like that, high fours and approaching 5%.

I think, should be expected as we get into 2026. Now what the Federal Reserve is trying to be careful of as they address this softness in the labor market, is that they don’t stoke inflation. So if you decrease interest rates, that results in easier financial conditions. And just in general, what the fear is, is that if you’re too early and you’re too aggressive, that can start to push prices higher as people have more money to spend.

We haven’t really seen any evidence of that quite yet, but I do think that that’s something that the Federal Reserve is watching very closely. Hence some of their caution in being aggressive on declining interest rates. Then finally, what I would say is, you know, just as a bottom line, I’m expecting sturdy growth, somewhat stagnant jobs market, but just really some greater stability in prices as we get into 2026 in the back half.

I’m not overly concerned about inflation, but really it’s it’s the two variables that the fed watches, labor and inflation that are going to be very important as we get into 2026 and data becomes more up to date. Got it. Okay. So with regards to AI, it’s having a meaningful impact on the economy. It’s also having a meaningful impact on the stock market.

And a lot of the tech companies related to I have seen a jump over the course of 2025. Are we let’s let’s shift now to equities on that front. Are we in a bubble? There’s a lot of people talking about a bubble in the stock market. Are we in a bubble. Yeah I mean it’s it’s by far and away the most prevalent question in client.

And any investment related conversations that we’re having right now. And, you know, I’ll give a longer spiel on this, obviously, but the short answer is no, we’re not in a bubble. Not at least from my perspective. I can first show you a chart that will cause some concern and rationalize some of the investor fears that are citing.

We’re in a bubble right now, and it’s time to go to cash. And then after that, I will I will hopefully provide some, some items that can assuage those fears and, and maybe counteract them to a certain to a certain extent. But if you look at the chart that I’m showing you right now, what it’s showing you on the bottom, the x axis, its forward price to earnings ratio.

So higher meaning more expensive. And on the left, you’re seeing the forward ten year annualized returns from those various PE ratio points in time. And what you’ll see is this is a very linear chart, meaning that as price to earnings multiples are higher, at least historically speaking, your forward ten year return is lower. And so what would that tell you about right now with a forward price to earnings ratio of the S&P 500 index around 23 times earnings, it would tell you that historically speaking, on this linear chart, that your forward ten year return is 1.65%.

Seems pretty low. It’s pretty low, right? Especially when you look back at the long term average of the S&P 500 index being close to 10% annualized. What I would say about this is, yes, it’s important to be selective with valuations and whatnot for any investor. But the other thing I would say is that a simple price to earnings ratio does not tell the full story.

What this chart is showing you is forward price to earnings multiples, which means that you’re taking, today’s prices divided by what is expected to be the next 12 months of earnings, not, you know, the previous 12 months of earnings. So it is forward looking to a certain extent. But we’re looking at ten years worth of total return on this chart as well.

Right. So so why don’t we also look at, you know, more than just the next 12 months of earnings growth, to try to derive an accurate valuation, multiple. And so to do that, you know, this next chart is, is, is basically incorporating what I would argue as, a more prudent way to look at markets today.

So there’s a ratio called the peg ratio. It takes that price to earnings multiple and divides it by the long term expected growth rate of operating earnings. In this case it’s the S&P 500 index. And so what you will see is that all of the sudden, instead of being overblown from a valuation perspective, the S&P 500 index looks a lot closer to average.

And a lot of that is is due in part to, the S&P 500 being a cap weighted index. We’ve talked so much about how information technology and the like has dominated the market, both from a return perspective, but then also from an allocation perspective. The S&P 500 is dominated by the tech sector. And I don’t have as much of a problem with that.

Right now as I maybe once would, partially because that’s where a lot of the earnings growth is coming from. So when we have this conversation about, are we in a bubble? I would argue no, mostly due to the fact that the companies that have gotten bid up or have been bid up because they are the ones that are growing their financials in the in the fastest way possible across the market?

Yeah. So I guess let me say in a different way, like the tech boom in the late 90s when all you needed to do was latch.com on the end of your business name, the company value doubled, but there wasn’t really meaningful earnings necessarily at that time. Today it’s an entirely different business model. There are meaningful, real, tangible earnings that are coming along with these companies.

And for that earnings drive price. If earnings are growing at a skyrocketing pace, price should fall. Yeah, that’s absolutely right. And I just think it’s interesting because you know we run a with in my investment committee. We have some some scoring metrics that we look at this scoring model that we use. It has a host of fundamental attributes across the US equity market.

And if we were to blindly trust that proprietary scoring model, the portfolio would be about 65% tech. And what that tells you is that these companies are scoring very well from a quality perspective. These businesses are founded in really good earnings power. A lot of them with strong recurring aspects of revenue and also very healthy balance sheets.

That’s another thing that people don’t talk about, is that the financial soundness of a lot of these companies that have led the charge for the last three now calendar years, are in very good position, not just from an earnings growth perspective, but also from a financial quality perspective. And so I guess it’s certainly, again, you want to make sure that that portfolio positions are right sized.

Meaning if you do have positions that have become outsized, I do think it’s a worthwhile exercise to pat yourself on the back and make sure that those positions are let’s just call it somewhat back down to earth, because, you know, very realistically, you could have swings in the market and points in time where sentiment drives things for a quarter or two.

And, you know, those positions can depreciate in value somewhat rapidly. I think it’s impossible to not participate in the names that have driven the market over the last three years. But again, just making sure that that the portfolio remains diversified and these positions are not overly large. Got it. So yeah. Is there anything else on the bubble front before we shift to some other asset classes?

No, I think the last thing I would say is just that, you know, even if you were to look at outright valuations, there’s been a lot that’s changed over the last month and a half as we’ve rounded out 2025, the tech sector and tech plus, if you will, which includes some aspects of communication services. You can’t really make the argument anymore that they are outright overvalued.

At least I don’t think so. You know, when I look at the tech sector, for example, on a forward on a forward peg basis, I mean, it really is actually the third cheapest sector in the S&P 500 index, which is which is kind of crazy because, you know, everyone just wants to look at price in absolute terms and just term.

Something is cheaper, expensive. But again, like I think you have to go a layer deeper and make some assumptions about the future in order to make investment decisions. And that’s exactly what we’re trying to do here at blue Chip. So when we see the tech sector start to taper off from a valuation perspective, yes, I want to make sure positions are right size.

I’m not going to go full bore into the sector, but I just think it’s it’s worth talking about because I’m not hearing it. I’m not hearing the equity market in the US discussed in this manner as much as I think it should be. It’s really interesting, really, really good. So okay, let’s shift over. So we we were talking about the S&P 500, which is predominantly domestic companies that are in the large cap or mega cap space.

But there are other companies that are smaller, small cap. There are other companies that are outside of the United States like international. What are we seeing outside of the S&P 500 in terms of small cap international? Any other comments that you want to make regarding equities? Well, it’s interesting because with all the fanfare that has been about with regards to large cap tech and dominating returns over the last few calendar years, we are quietly having something happen underneath the surface that hasn’t happened in almost 20 years.

And that something is that for the first time, since 2006, on an equal weighted basis, U.S. small cap and international equities are on pace to outperform US large cap equities. That hasn’t happened. You haven’t had both. Small cap in the US and international equities outperform large cap, large cap U.S. equities since 2006. And again I no one’s talking about this because what’s in the headlines is artificial intelligence related companies.

And you know US tech. That’s what’s dominated headlines. And it’s not you know the fact that you are seeing a bit of but a bit of a bump from some underappreciated areas of the global equity market, a broader rally. It’s broader than just tech and the tech sector and the S&P 500. You’re really seeing this across multiple asset classes.

Yeah, you really are. And and you know I think the question that any, you know, prudent investor would ask now is well can this momentum continue into 2026. So I do think it’s it’s a tale of two stories. You know I’ll talk about small cap first and then I’ll talk about international second. But I think the short answer is yes.

I mean, I actually do think that the momentum can continue for both small cap and international, with the latter narrative being a little bit more nuanced. What I would say about small cap is lower rates can continue as a tailwind. I’ll flash back to something we talked about. It would have been around this time last year.

And it’s that, generally speaking, in declining interest rates and and declining in street environments, small caps are disproportionate beneficiaries relative to large cap. And you can talk about the reasons as to why that is. The interest rate burden being higher for smaller companies than larger companies. Generally speaking, cyclical points in the economy when you’re cutting rates can coincide with, when optimism starts to flare up for smaller companies, whatever it might be, I think the interest rate story is easiest to talk about.

So what I’m showing right now is, is actually the same chart that I showed. It would have been in the third quarter, fourth quarter of 2024. But I’ve just added in additional data to be up to date for the current interest rate cutting cycle we’re a part of, which kicked off in July of last year. And what it’s showing you is that on the x axis, as you’re moving to the right, it’s years since the first rate cut of a given cycle.

And on the left hand side, it’s the excess returns of small caps relative to large caps on an equal weighted basis. And what you see is that as you kick off a rate cutting cycle and you progress through that over the following three years, there does tend to be cumulative outperformance that’s exhibited by small cap stocks relative to large cap stocks on an equal weight basis in the US.

And you know, realistically, the the story has kind of lined up for this current rate cutting cycle relative to historical cycles, at least since 2000. And so I’m showing this not not to pat ourselves on the back or anything like that, but just to to kind of bring to light these are the, the way that we, we make investment decisions.

Right. You do want to put some stock in what history has shown you. But not put all your eggs in that basket. You know, we always say that, you know, history, might not repeat itself, but it certainly could rhyme. And I think that’s kind of what we’re seeing right now. So the fact that the path of least resistance for interest rates still is lower.

I do think that you still have that main tailwind behind small cap stocks here in the US, but does that, and anything else on international that you want to blend in that. Yeah. I mean the again the international story is a bit more nuanced. It’s not like you can point to one major tailwind like we can with small cap and interest rates.

But what I would say is, I mean, both small cap and international stocks, people have been making the argument for, I guess, decades at this point around the valuation mismatch. Small cap stocks and international stocks are so much cheaper than than us. Large cap. One thing to keep in mind for, for the international side of the equation is that the construct of of that market versus the US is completely different.

It’s much more oriented towards cyclical areas like financials or materials energy, maybe less so health care. But I guess my point is the, the, the, the bulk of the market in international stocks is geared towards lower valuation sectors. Right. So it’s not it shouldn’t be a surprise that you have a persistent valuation discount prescribed to international companies.

And so while you have seen that kind of re rate higher this year or I shouldn’t say re rate higher, I guess international equities have decreased that valuation valuation discount over the course of this year. I do think that some of that can continue, but I don’t want that to be in investors mind as the kind of be all end all piece of the thesis.

In reality, for me, I think it’s it’s much broader. It’s things like the US dollar, the US dollar has declined meaningfully relative to other major currencies this year. I think there’s room for that to continue. Especially as the Federal Reserve lowers interest rates that generally can coincide with a lower US dollar valuation. And, you know, that’s a benefit to international stocks.

There is a reasonable degree of correlation between a declining U.S. dollar and international stocks heading higher. So if you do get that continued environment, that continued momentum lower for the US dollar, I do think that that ends up being a boon for international stocks. Unless you get some sort of U.S growth stop growth shock, which would shift the US dollar higher.

But I don’t see that as a base case. The other thing to think about is there’s been a bit of a pivot. Let’s just talk about Europe for a moment, as you know, kind of the guinea pig here. But there’s been a bit of a pivot towards more expansionary policies, particularly in companies or, sorry, countries like Germany, where you’ve seen just a total revamping of of how they’re thinking about the future.

And I think what they’re doing, and they are kind of a just an embodiment of a number of different countries in Europe that are putting forth policies that are aimed at enhancing economic growth. And that, again, is part of the reason why you did see international outperform the US in 2025. Those policies and that stance that’s shifting in stance is not going away.

And so putting all of this together, I think there’s room for that Momentum International to continue. Again, it’s just a bit more nuanced because again there’s a lot of different factors at play here. Yeah. Great. Let’s wrap up with bonds. What’s what’s the story of bonds. Yeah. I mean, look, the I think that bonds have remained, in a position to provide that ballast in investor portfolios, and especially as we get this declining interest rate environment, I think the value proposition remains strong and, honestly, could get even stronger.

As you have bonds that are, let’s call it in aggregate, just looking at the Bloomberg US aggregate bond index, just the predominant domestic bond index, yielding roughly, you know, four, 4.5%. You know, there is a there’s a high degree of correlation between what you’re starting yield is today and your five year or ten year forward total return in that investment.

And so, of course, you know, you would think, well, why would I lock in, you know, prices or lock in a yield today if it’s going to be higher tomorrow, etc., etc.. Well, I think the idea here is that the path of least resistance, as I said before, for interest rates, is lower. Bond prices and yields move in opposite directions.

So as you have this this tailwind from the Federal Reserve, I do think the passive path of least resistance for bond returns is higher. I mean, you said it best when, we were kind of prepping to record this, and saying that, look, just because I’ve got the wind at my back, it doesn’t mean I’m going to have my best nine holes of golf ever.

But it certainly doesn’t hurt. Right? I would much rather have that than being forced to head into a headwind for nine straight holes. Right. So I think putting all of this together, you’ve got us economic growth prospects that have remained reasonable. In the event of any more meaningful slowdown, I think that would only result in the Federal Reserve cutting rates faster and more aggressively, which, again, can be a benefit to bonds and overall, I think that the backdrop of where we’re at today just underscores the ability for bonds to provide an attractive portfolio diversification mechanism.

The chart that I’m showing on the screen right now, it maps out another linear path through history in the sense that as you move from left to right, your bond yields go from low to high. And on the, on the left hand side of the chart, if you go from lower to higher, you can see that as your yield.

Your starting yield is higher. Your forward five year return has historically been higher. Right. So I guess the point being I’m not going to talk about, you know, what we’ve talked about over the last couple of quarters, being that it’s an attractive time to shift from money market exposure to traditional bond market exposure, I think that still holds.

But I guess the end takeaway here is that you have a pretty reliable instrument in U.S bonds where you don’t have to reach for yield and you have wind at your back. So let’s not overthink it. Let’s get back to strategic asset allocation targets. Maybe take some profits from winners and make sure you’re in position to weather any storms that might come about in the early innings of 2026.

Awesome. You know, really nice overview. I think we covered it all. Is there anything else you want to add? No. Nothing else. Excited to, close the books on an exciting 2025 and, just excited to see what 2026 holds for us. Well, thank you for everything. You do appreciate the overview. My pleasure. Thanks for joining me, as always.