Solid Prospects for 2026

Market Dynamics

Job growth decelerated sharply in 2025 compared to prior years, but it remains quite solid relative to growth in the labor force. Inflation remains a bit above the Fed’s 2% target, but productivity gains from AI could potentially bring it down, even as the tight labor market threatens to push it higher. Thus, the outlook for inflation remains uncertain and these competing forces could result in a stalemate. Nonetheless, it is clear that corporate profits are performing very well, while interest rates are fluctuating, but only narrowly. This is a very satisfactory combination auguring more gains in the equity market, while bond investors could earn their coupons.

Comparing Immigration Trends and Workforce Growth

It is common for critics to disparage the economy’s performance by pointing out that job growth averaged a mere 49,000 monthly in 2025 after averaging 168,000 new jobs in 2024. However, 2024’s performance is not a suitable basis for comparison. The borders were open for much of President Biden’s term, and millions of job-hungry immigrants came in to look for work. They readily found job opportunities, and domestic growth surged. Once the border closed, and some immigrants were sent back home, domestic business was forced to rely largely on native job seekers. Demographically, our domestically sourced workforce is growing about 50,000 monthly, give or take as much as 25,000, so actual job growth in 2025 was in rough alignment with labor force growth. It is hard to be more precise, as yet, since estimates for the growth of the population and labor force are distorted by the surge of illegal immigrants for several years. It may take more than a few years to get reliable numbers, potentially not until the next census in 2030. Until then, we may be dependent on indirect indications of labor market tightness, such as wage inflation. If wage inflation increases, it would be an indication that the labor market is tighter than estimated. Moreover, new business formation is running at nearly 12,000 weekly, more than double the pace of a decade ago. We may not be capturing all the new jobs associated with these new firms.

AI Productivity Gains and Wage Inflation

Alas, wage inflation also may be less insightful right now, because it is affected by other forces, notably AI. AI adoption is proceeding rapidly and it will take some time to figure out the many ways it is affecting the economy, along with all its consequences. We do know that many jobs are being displaced by AI. Anecdotally, I’ve had reason to call my bank, an airline, and my cable provider over assorted issues within the past two weeks, and to my absolute shock, every single issue was resolved quickly and satisfactorily by a computer without the intervention of a human being. (I still hate my cable company.) Impressive? Absolutely. Scary? Very. The machines are making vast inroads into jobs previously handled by humans. And we are still in the early stages of what’s possible, or so we are told by AI experts. We know that autonomous vehicles are already safer than human drivers, although we are still not ready to turn over the roads to them completely. The same appears to be true for computers over human pilots. But what is notable economically is that these technological strides reduce business costs, thereby offsetting labor expense, which contains inflation. So, those 4% wage gains could translate into less inflation than they have historically. This promises faster gains in real income and living standards. The same thing happened during the internet bubble, when rapid adoption of the internet also mitigated rising labor costs and boosted real incomes.

Federal Reserve Policy and Market Implications

Insofar as policy is concerned, the slower pace of job growth reflects the inability of firms to find domestically sourced labor. Labor scarcity precludes any moderation in wage inflation, which remains high. But productivity gains stemming from AI could prevent any rise in wage inflation and could also provide some offset to possibly bring inflation down. It will be difficult for the Fed to process such unusual data, but the safest path for them is to take their time waiting for more data to see how everything plays out.

Equity Markets, Corporate Profits, and 2026 Outlook

As for the markets, the economic environment described above is very positive for equities. Slow job growth will still translate into solid or strong economic growth, as productivity lifts GDP. The latest Atlanta Fed estimate for Q4 GDP growth exceeds 5%. While AI mitigated inflation, corporate profits performed very well, being revised higher multiple times over the course of 2025, despite the “slow” job growth. This trend appears set to continue in 2026. Thus, we expect solid GDP growth, correspondingly strong profit growth, only modest changes in inflation, and therefore, only modest changes in interest rates. This combination creates an almost ideal environment for stock prices.

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