Is a market correction coming?

U.S. equity markets opened 2026 near record highs after a powerful rebound from last year’s volatility. ¹ Since April, when the S&P 500 narrowly avoided a bear market (a 20% decline or worse), investors have dismissed concerns about higher tariffs and the concluded government shutdown. Instead, they have refocused on company fundamentals and steady economic indicators like robust consumer spending.

Tariffs and policy shifts shape market moves

President Donald Trump’s new tariff policies triggered 2025’s February to April decline, then set the stage for the recovery as the President eased the most restrictive measures. “Stable consumer spending and improving corporate earnings enabled investors to look past tariff impacts,” says Bill Merz, head of capital markets research with U.S. Bank Asset Management Group. “However, investors continue to question the sustainability of artificial intelligence (AI) spending and the Federal Reserve’s rate cutting pace.”

Negotiations, implementation timelines, and courts drive the next tariff chapter

The U.S. has negotiated multiple tariff arrangements—such as 15% rates with the European Union, Japan, and South Korea—and secured a one-year deal with China. The administration also announced additional sector-focused tariffs (including categories like softwood lumber and certain home-related products) though recently delayed implementation until 2027. Legal challenges also remain a live variable, and investors expect an early 2026 Supreme Court decision determining the President’s power to impose tariffs without Congressional approval.

The tariff math is real – and it shapes cost and pricing decisions

Average tariff rates now sit near 12% on imported goods, up from roughly 2% at the start of 2025.  ² If negotiations fail to lower announced tariffs, the Yale Budget Lab estimates the effective rate is near 14.4% after consumption shifts. ²

“Tariffs in place now address specific sectors, trade fairness issues and even geopolitical concerns,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group. “Rising tariff rates for major trading partners, such as China, Canada, Mexico and the European Union, raise U.S. import costs.”

AI still leads, but leadership comes with valuation questions

Information technology and communication services stocks reasserted leadership after a slower start in 2025, with AI related firms powering much of the rebound. ¹ Businesses are adopting AI to automate workflows, improve decisions, and deepen customer engagement—supporting strong growth expectations for the ecosystem and its infrastructure. Even so, elevated valuations have made the trade more sensitive to disappointment, so pullbacks can arrive quickly as investors reassess the AI-spending cycle. ¹

The rally is widening beyond a single theme

As 2026 begins, more sectors are contributing, and leadership has broadened across financials, industrials, healthcare, and utilities. This matters because broader participation often signals healthier market depth than a rally driven by only a handful of names. The “One Big Beautiful Bill Act's” business stimulus measures have lifted earnings expectations and investors are also taking note as mid- and small-cap stocks respond to improving economic data and renewed expectations for lower borrowing costs.

Inflation outcomes remain uncertain

Many economists expected tariffs to push inflation higher, but Consumer Price Index (CPI) changes stayed modest 2025. ³ “We saw decelerating core goods price growth, but investors should expect some additional inflation in coming months,” says Tom Hainlin, national investment strategist with U.S. Bank Asset Management Group.

Over the past year, core CPI (which excludes volatile food and energy prices) rose 2.6% in November, decelerating from August’s 3.1% annual pace but remaining above the Fed’s 2% inflation target. ⁴ Meanwhile, Federal Reserve surveys of its 12 regional districts reported widespread tariff-induced input cost increases across manufacturing and retail businesses, and the key question is how much of that pressure reaches final prices. ³

Government shutdown risk returns in 2026

To reopen the federal government in November, lawmakers provided full fiscal-year funding for veterans’ programs, food aid, farmer assistance and Congressional operations, concluding September 30. The deal only funded other government agencies through January 30, 2026 and investors are watching the risk of a partial government shutdown starting January 31. Consumers are facing pressure from expiring Affordable Care Act healthcare subsidies, though the current budget deal funds some of the most sensitive programs, which account for just 10% of the government budget.

The prior shutdown already delayed key data releases including consumer and producer inflation, monthly retail sales, housing activity and the Bureau of Labor Statistics’ employment report. However, high-frequency alternative data including movie theater box office receipts, airport checkpoint traffic, restaurant bookings and private sector retail sales gauges reflect resilient consumer activity. Investors and the Federal Reserve continue to evaluate the quality of economic releases as they make decisions amidst the gap in data releases.

Policy changes and market reactions

Last July, lawmakers passed comprehensive tax and spending legislation, extending 2017’s tax cuts, adding other tax breaks and raising the debt ceiling. Markets responded favorably, and some corporate executives cited these changes for boosting profit expectations. The Congressional Budget Office forecasts an additional $150 billion in consumer stimulus via tax changes, which should occur as individuals begin receiving tax refunds in early 2026.

As equity prices climb, investors wonder if upward market momentum can continue. “Valuations are elevated,” says Haworth. “But companies remain nimble.” He notes that analysts are raising 2026 earnings forecasts, supporting upward-trending equity prices.

Rate cuts helped reset expectations, but the path forward remains the key variable

Investors closely monitor the Federal Reserve (Fed) because its policies directly influences short-term interest rates and indirectly shape global borrowing and financing costs. The Fed has actively reduced the federal funds target rate, cutting it by 1% in late 2024 and by another 0.75% over the three meetings to conclude 2025. These actions brought the fed funds target rate to a 3.50% to 3.75% range, reshaping expectations for where financing conditions might settle next. Median Fed member projections anticipate another 2026 cut, although investors expect two to three additional cuts, highlighting how quickly market pricing can diverge from official Fed guidance. ⁵

President Trump remains publicly frustrated with the slow pace of interest rate cuts, even suggesting firing Fed Chair Jerome Powell, whose term as Chair ends in May. President Trump indicated at a December 2^nd Cabinet meeting he would announce a replacement early next year. “The President is saying what every borrower wants to hear: that we want lower interest rates,” says Hainlin. “At the same time, the Fed continues to emphasize two of their primary objectives – promoting full employment and ensuring stable prices – and that they’re doing their jobs well. It’s a collision of two principles.” Markets typically react positively to Fed rate cuts, but inflation risks linked to tariffs continue to influence Fed policy and equity prices.

A time for appropriate diversification

Determining the right asset mix for your portfolio involves making investment decisions that suit your personal situation, not just reacting to market and economic trends. The current market environment reflects lessons from history – stay invested and diversified, despite market volatility and uncertainty. Significant market swings like those experienced in 2025 are nothing new.

Haworth advises those who held cash as a precaution and missed the recent market rally to use a dollar-cost averaging approach to invest over time. While markets at new all-time highs sometimes present risks, Haworth also notes, “New all-time highs are often followed by new all-time highs.”

Now is an important time to check in with a wealth planning professional to ensure you are comfortable with your current investments and that your portfolio aligns with your time horizon, risk appetite and long-term financial goals.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. Diversification and asset allocation do not guarantee returns or protect against losses. The Russell MidCap Index provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500, is designed to measure the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment. The Russell 2000 Index refers to a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index.