U.S. stocks pressed higher on Friday after the December jobs report helped quiet concerns about the state of the U.S. labor market.
The advance was strong enough to land a fresh round of record closes for the S&P 500 SPX and Dow Jones Industrial Average DJIA. But perhaps even more remarkable, the small-cap Russell 2000 RUT and midcap S&P MidCap 400 MID indexes also put in new highs of their own, FactSet data showed.
The fact that shares of smaller, more economically sensitive companies outperformed on Friday - and this week as a whole - offers a few clues about what issues are front and center for American investors in 2026. To quote Democratic political strategist James Carville, who helped Bill Clinton win the White House in 1992: "It's the economy, stupid."
Friday's jobs report was hardly spectacular. But the decline in the unemployment rate helped undercut expectations for more interest-rate cuts from the Federal Reserve in the near term. Futures traders aren't expecting another cut until at least May, and maybe even later, data from CME Group showed. And although the report showed just 50,000 jobs were created last month, Michael Feroli, chief U.S. economist at J.P. Morgan, said this was "good enough" for job-market stability.
Over the past few months, expectations for more interest-rate cuts by the Federal Reserve appeared to be the big story in markets. But on Friday, stocks rallied even as fed-funds futures reflected a lower chance of another rate cut before the second half of the year, according to data from CME Group.
Strategists at BofA Global Research said Friday's data helped bolster their belief that the Fed won't cut rates again until Fed Chair Jerome Powell's successor takes the reins.
As more cyclical areas of the stock market start to break higher while the information-technology sector struggles, investors appear to be embracing hopes that an accelerating U.S. economy could shower investors with broad-based gains and earnings growth. This was a popular theme from the 2026 year-ahead outlooks published by major Wall Street banks and investment firms, and shared with MarketWatch last month.
"AI is getting tired and Wall Street is looking for other areas of the market that could bolster stock appreciation - and when you have a reaccelerating economy and rate cuts, that's really good for a lot of the areas of the market that haven't really participated over the past few years to the extent that tech has," said Jose Torres, a senior economist at Interactive Brokers, during an interview with MarketWatch.
The bull market began in late 2022, when nearly every economist on Wall Street was still expecting the Federal Reserve's aggressive interest-rate hikes to instigate a recession as the central bank looked to tamp down the worst wave of inflation in decades. For its first two years, gains during this bull market were heavily concentrated among shares of companies with heavy exposure to the artificial-intelligence theme. Members of the so-called Magnificent Seven performed particularly well.
But that started to change last year, as more stocks and sectors joined the rally. Meanwhile, the Magnificent Seven saw their relevance fade: Only two members of the megacap tech cohort outperformed the S&P 500 last year, even if gains for these stocks still contributed mightily to the index's 17.9% total return, including dividends.
Ed Yardeni, founder and president of Yardeni Research, articulated the reacceleration thesis in commentary shared with MarketWatch late last year. His base case has U.S. GDP growing between 3% and 3.5% in 2026, quicker than the 2% to 2.5% expected for 2025. With growth in the labor force expected to be modest, much of these gains will likely be driven by a sizable increase in worker productivity.
That should lead to stronger profit margins, all else being equal. Wall Street analysts are already penciling in strong earnings growth - not just for large-cap companies, but for small-cap firms as well, FactSet data showed. This should help keep pushing stocks of all sizes higher.
"Our year-end 2026 target for the S&P 500 assumes that the economy and earnings will remain resilient. Our odds of a severe correction or a bear market, triggered by either recession fears or an actual recession, remain low at 20%," Yardeni said.
Based on recent data, it would appear that the U.S economy started to pick up steam in late 2025. GDP data for the third quarter showed the economy grew at an annual rate of 4.3%. The latest estimate from the Federal Reserve Bank of Atlanta's GDPNow forecasting model expects that pace quickened to 5.1% during the fourth quarter. Growth has been bolstered by ongoing investment in the AI buildout, along with the fact that consumers have continued to spend, even as some struggle with higher prices.
With the full impact of President Trump's tax cuts from the One Big Beautiful Bill Act still yet to be felt, strategists like Yardeni believe the pace of growth is probably poised to quicken further. And it's not just tax cuts for consumers, as Yardeni pointed out; spending on capital investment by companies is expected to pick up as well.
The One Big Beautiful Bill Act included a provision that expanded qualified bonus depreciation for certain investments. This will save companies money on taxes in the short term, encouraging them to invest more aggressively in capital projects.
One worry hanging over investors' heads: Midterm election years tend to coincide with weak stock-market returns, Torres noted. But the possibility that President Trump could push through more spending to boost Republicans' chances at the ballot box - perhaps in the form of tariff rebate checks, as Trump has publicly mused about doing - could help investors look past these historical patterns.
Ultimately, equity bulls are hoping the U.S. economy reverts to the "Goldilocks" environment that persisted for much of the 2010s. Of course, a revival of inflationary pressures could throw a wrench in the works, said George Cipolloni, a veteran portfolio manager who spoke with MarketWatch.
But for now, at least, investors are feeling optimistic - and stocks could easily ride that wave to another year of strong returns.
-Joseph Adinolfi