Stock Market Outlook 2026: Will the Bull Run Continue or the AI Bubble Burst?

After a year in which investors were plagued by rampant uncertainty, valuation concerns and AI's undefined future, the market's big reward in 2026 might just be a little more clarity.

A large part of that could come from the Federal Reserve, which again cut rates in December, marking the central bank's third 25-basis-point reduction of 2025 and paving the way for more favorable market conditions in the year ahead.

"You could end up with a much more dovish Fed by the end of the year," says Jason Blackwell, chief investment strategist at Focus Partners Wealth. "If they can build a consensus around the rate path, then you can expect interest rates to continue lower."

Blackwell notes that lower rates — and, subsequently, lower borrowing costs — are generally good for both consumers and companies' capital expenditures (CapEx), which in turn are favorable for stocks.

But the Fed's monetary policy is just one of handful of factors that will shape the market's performance in 2026. And while there are plenty of reasons for investors to be optimistic, there is also cause for concern.

The stock market's performance could hinge on AI

Analysts' 2026 year-end price targets for the S&P 500 run the gamut, reflecting varying positions on how tailwinds, including a potentially dovish Fed and an expected uptick in mergers and acquisitions, could compete with headwinds like the midterm elections and souring consumer sentiment.

Currently, the index is trading around 6,899. From more bullish projections like Deutsche Bank's price target of 8,000 to more conservative projections like HSBC's 7,500, Wall Street is largely expecting the index to finish 2026 in the green.

But as was a theme for much of 2025, no single factor may impact the S&P 500's performance next year quite like AI.

" It's pretty easy to build a pilot around AI. It's really hard to make it scalable. So if 2024 and 2025 were the AI CapEx story, 2026 becomes the 'show me' story," says Blackwell. "What we really want to see... is AI adoption really taking hold and resulting in productivity improvements and earnings improvements."

If those improvements come to fruition, AI could serve as the proverbial rising tide that lifts all boats, says Blackwell. But that would require the involvement of corners of the market that missed out on the AI rally over the past two years, like health care and industrials.

Analysts at Morgan Stanley share that belief. The investment bank's 2026 investment outlook noted that "companies and economies are likely to benefit from AI-related productivity gains," adding that an "unusually favorable [fiscal, monetary and deregulatory] policy mix allows markets to shift focus from global macro concerns to asset-specific narratives — particularly those related to AI investments."

But concerns about elevated valuations remain. On Dec. 1, Yahoo Finance reported that analysts at Wells Fargo see AI expanding beyond its current state of tech-led growth. Still, they cautioned investors that, despite the fervor, AI could still become a bubble.

How tariffs, inflation and the midterms could affect the stock market in 2026

Another theme likely to carry over into 2026 is President Donald Trump's tariff policy, which could continue to have an outsized impact on facets of the S&P 500 that are sensitive to shifts in consumer spending.

In November, a University of Michigan consumer survey showed sentiment was 29% lower than the year prior.

The survey also highlighted year-ahead inflation expectations of 4.5%, up substantially from the current consumer price index reading of 2.7% and well above the 2.2% that the National Bureau of Economic Research determined would have been the CPI had the president not enacted his aggressive trade policies.

"While the economy slows... we are also unfavorable on the consumer discretionary sector as tariffs ratchet higher and lower-income consumers continue to struggle," Doug Beath, global equity strategist at Wells Fargo wrote in November.

Blackwell says that Trump may be more mindful about tariffs in 2026 since it's an election year, though that may not be enough to steady the market.

Since 1957, the S&P 500's average annual return is 10.54%. According to data from U.S. Bank, in the 12 months preceding midterm elections, the index's average return is just 0.3%.

The good news: Long term, investors should remain optimistic

While annualized market performance is a critical component in forecasting stock performances, one year remains a short-term measure. However, investors have reasons to remain optimistic about equities' returns over the medium and long term.

"It's really easy to sketch out downside scenarios," says Blackwell. "But whether you're looking at AI or Fed changes, we think investors are well-suited to enjoy the upside scenarios, which have higher probabilities."

In particular, he warns against sidelining cash due to fears about potential market downturns. Data shows that over the past 30 years, investors who missed the market's 30 best-performing days would have seen 83% lower returns.

"Missing out on a significant rally is arguably more damaging than sitting through some volatility over the course of a year," Blackwell says. "Stick to the long-term view and be patient."

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