CONTRIBUTORS
Chris Galipeau
Senior Market Strategist
Franklin Templeton Institute
Lukasz Kalwak, CFA
Market Strategist
Franklin Templeton Institute
Overview
- Despite the solid gains in global equity indexes in 2025, we still believe conditions remain favorable for the rotational bull market to continue.
- We expect real US gross domestic product (GDP) to grow at 2.5% with moderating inflation, ongoing Federal Reserve (Fed) interest-rate cuts, a robust fiscal impulse and a broad-based earnings recovery to drive further equity gains over our tactical horizon. With the Fed likely to ease, monetary easing may continue in many emerging markets as well.
- We think market leadership will continue to broaden and that two often-overlooked equity market segments are poised to outperform: US small caps and emerging markets (EMs).
This paper serves as a sequel to three research papers we published beginning in January 2025 and offers a potential road map for investors seeking opportunities in 2026. We will discuss the following:
- Market broadening—revisiting our January 2025 theme
- What’s ahead—potential for an earnings-driven bull market
- Why small caps may shine
- International opportunities are still compelling, with EMs poised to lead
Conclusion
With the US economy showing strong growth and the Fed resuming its interest rate-cutting cycle in 2025, the environment looks increasingly favorable for corporate earnings to expand. It may be an opportune time to consider increasing allocations to equities, as our research indicates they are poised for potential further gains.
Our research themes in 2025 emphasized the likelihood for equity market performance to broaden beyond the Magnificent Seven.1 As we have entered 2026, our analysis of the capital markets continues to favor the likelihood of broadening performance. Here, we highlight two areas of equity markets that may be especially attractive—US small caps and emerging markets. Investors often avoid these areas of the market, but we believe they should instead take a closer look.
The recent struggles of small-cap companies can be attributed primarily to their vulnerability to rising interest rates, which significantly increased borrowing costs and pressured their profitability. However, with interest rates now at lower levels and perhaps more rate cuts ahead, the outlook for small caps is becoming increasingly favorable.
As a result, this rate-sensitive asset class may experience a notable resurgence in performance. Our research finds valuations attractive on an historical basis, adding a potential tailwind to performance.
EMs are also becoming more attractive. Easing global monetary conditions should make local funding cheaper for EM companies, while also improving currency dynamics. Our research shows EM equities are currently undervalued relative to developed markets, offering what we consider significant upside potential as global financial conditions stabilize and growth prospects improve. We believe companies in EMs that are projected to deliver stronger earnings growth than their counterparts in the United States, Europe and Japan, now may be an opportune time to consider increasing exposure to this asset class.
Endnote
- The Magnificent Seven refers to Apple, Microsoft, Amazon, Alphabet (Google), Tesla, Nvidia and Meta.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Diversification does not guarantee a profit or protect against a loss.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Large-capitalization stocks may fall out of favor with investors based on market and economic conditions.
Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.
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