AI and the Melt-Up in Equities
The melt-up in major equity indices was largely driven by AI and AI-adjacent stocks, particularly mega-cap companies. This isn’t surprising considering that artificial intelligence is supposed to have profound effects on the economy and our general way of life. Exactly what these long-term effects will be remain unknown but as with past technological advancements everything will likely occur in waves.
The current AI wave likely looks like:
First wave:People use AI mainly as search. Second wave: Use AI seriously for productivity. Third wave: Agentic AI (AI acting autonomously on tasks).
Currently we are firmly in the first wave, which started a few years ago with the launch of ChatGPT. There is a lot of hype around the second and third phases, and both businesses and governments are making significant investments toward these goals. A lot of that hype is what drove equity prices higher this year and will determine whether it continues in 2026.
Productivity Hopes vs. Reality
Indeed, based on valuations, markets are pricing in a big productivity tailwind from AI. There is some anecdotal and indirect evidence that AI is already resulting in a productivity boom. For example, one could argue that the recent downtrend in the length of the average workweek and the slowdown in hiring, alongside no outright spike in layoffs, is actually a sign of businesses using AI to “do more with less,” i.e., greater productivity.
As for classical productivity measures, though, the evidence so far remains lacking, e.g., trend productivity growth is currently only around 1.5%, decent but not the “boom” implied by recent AI hype. On the bright side, concrete productivity benefits historically tend to show up after the adoption phase. Consider the computer and internet boom of the late ‘90s. The major productivity surge didn’t actually show up in the data until 2000-2003, after the dot-com bubble burst.
Three Scenarios for AI and the Market
The risk for stocks is that the expected productivity boost doesn’t materialize “on schedule,” which would severely challenge the prevailing margin expectations of investors. Altogether there are likely three scenarios for the current AI regime and how markets react:
Dead end (bearish): The large language model (LLM) approach eventually fails, with diminishing returns despite escalating costs. True AGI/ASI never materializes, though it may take years to confirm this. Delayed payoff (inflationary, near-term bearish): The current AI buildout is the right path, but profits are years away. In the meantime, infrastructure spending drives up costs (e.g., electricity inflation for consumers), crowds out other industries, and fails to deliver immediate productivity gains, leaving the economy “sickly” and markets disappointed. Already working (bullish): AI is already boosting productivity in visible and hidden ways, with effects likely to accelerate faster than expected. If true, the economy should perform surprisingly well even amid tariffs, trade disruptions, labor shortages, and massive AI spending.
Broader Economic Risks in 2026
Beyond euphoric AI valuations there are more basic risks for equities in 2026, such as the economy. Indeed, the “quits rate” has fallen to fresh lows, suggesting workers feel less confident about job prospects. Layoffs also appear to be rising based on JOLTS data and WARN (mass factory layoff) notices, even if initial jobless claims remain muted. This combination signals a shift in bargaining power toward employers, implying slower wage growth and in turn softer consumer spending.
Broader employment risks in the year ahead come from the housing market, which was already in a recession in 2025, since housing construction is unlikely to add jobs given record unsold inventory. Low oil and lumber prices also discourage hiring in energy and materials sectors, and similarly higher education and state/local governments hiring is likely to remain depressed from budget cuts. As for inflation, it is fortunately trending in the right direction (down), but disinflation is not outright deflation, so households remain frustrated with the price gains that have already occurred during the past few years and no immediate relief in sight.
All of this could prove to be an even greater problem if the Federal Reserve remains reluctant to cut and risks in turn finding itself further behind the curve. Fiscal support for staving off a recession is also not certain as President Trump has touted the potential for tariff-related stimulus checks for Americans, and propping up the economy during a mid-term election year would be politically beneficial, but the actual viability of this and other large fiscal expenditures faces the hurdles of a divided Congress and trillions of dollars in national debt and debt-servicing costs (interest).
Volatility Ahead: Managing Expectations
Regardless, another large gain for equities is of course still possible for 2026, but a lot of things all have to go right for this to occur, and therefore altogether our base case is for volatility to at the very least pick up from the unusually low range we were spoiled with in the previous three years.
It is important to mention the potential for such choppier market conditions because after back-to-back-to-back years of double-digit gains in the S&P 500 it may be easy for complacency to set in, or even worse overconfidence that lures one to more speculative trading as opposed to tried-and-true long-term investing.
Recognizing this inherent cyclicality and the long-term nature of a 401(k) can provide a crucial foundation for maintaining a calm and rational approach during periods of market volatility. Read about Market Volatility: How to Navigate as a 401(k) Investor.
The Case for Long-Term Investing
The evidence in favor of why it is much smarter to be a long-term investor rather than a short-term trader is stark. On any given trading day throughout the stock market’s history, the odds of the S&P 500 being up on the day are roughly 53 percent. That beats any odds you could find in Vegas or a sportsbook, but it is still only slightly better than a coin flip.
Even more discouraging for any would-be day traders is a recent study which showed that many finance-trained adults struggled to make money timing the market even when they were provided the next day’s financial headlines in advance. Fortunately, most retirement-focused investors avoid the speculative allure and for them the odds of success improve substantially.
For all one-year time horizons, for instance, the likelihood of the stock market trading higher increases to 75 percent, and that goes up to nearly 90 percent over all five-year periods. Put simply, the longer you are willing to wait before checking the performance of your investments, the better your odds become of seeing a gain.
Going Into 2026 Optimistic
So altogether it is easy to go into 2026 optimistic if one sticks to the basics:
History tells us that the stock market trends higher over time. We are on average more likely to have another up year than a down year. If we do get a down year, investors should use it as a chance to add to exposure rather than trim it.
Of course, each investor’s unique personal situation, risk tolerance, and other factors may warrant a bit more nuance and customization for how to handle their investments in the year ahead, but as always that is exactly what we are here to help with. Make managing money more efficient and profitable with Slavic401k’s financial resources. Click here to explore!
Now onto 2026; here’s to a happy and healthy new year!
