Four Possible Market Pitfalls to Watch for in 2026

Ask how markets could stumble next year and answers likely include an AI "bubble," geopolitical flareups, sticky inflation, uncertain central bank policy, historical weakness before U.S. midterm elections, and slowing jobs growth. The first one comes up most frequently, as tech stocks suffered a tough December amid AI spending concerns.

Digging deeper, investors should be aware of other pitfalls that could cloud the picture after double-digit stock market growth over the last three years. Below are four possible concerns and four positive scenarios, each followed by measures investors might want to consider in preparation for a potentially volatile 2026.  

After a good 2025 for bond investors, positive trends are likely to continue next year. That said, credit worries briefly shook U.S. stocks in late 2025 as a handful of loans in the auto industry went sour and JPMorgan Chase (JPM) CEO Jamie Dimon warned that more "cockroaches" may be afoot. "Credit concerns have weighed on the prices of some of the riskier bond investments like high-yield bonds, bank loans, and preferred securities," said Collin Martin, head of fixed income research and strategy, Schwab Center for Financial Research (SCFR). "Default risk should weigh on the high-yield bond and bank loan markets." While few corporate bankruptcies have made headlines lately, the corporate default rate has been somewhat elevated since late 2023 with little fanfare. Anyone who remembers the bank failures of early 2023 knows how quickly a credit scare can affect Wall Street.

What's next? Investors should listen carefully to earnings comments in January from Dimon and other bank executives for possible new "cockroach" sightings. Results from smaller regional banks need checking, too, because that's where worries often flare first.

Weak consumer sentiment and other surveys, known as "soft" data, haven't meaningfully translated into less spending. Holiday shopping was resilient, according to retail firms, and October retail sales growth excluding automobiles was firm. "However, if the labor market continues to soften at the margin, inflation stays sticky, and affordability doesn't improve, consumption might look less robust in 2026 compared to 2025," warned Liz Ann Sonders, chief investment strategist, SCFR, and Kevin Gordon, head of macro research and strategy, SCFR, in their 2026 U.S. stocks and economic outlook. "That especially rings true if companies' increased investment doesn't lead to a surge in hiring—which is possible if the desire is to invest more in technological, as opposed to human, capital." As many have pointed out, consumer spending accounts for 70% of U.S. GDP.

What's next? The December nonfarm payrolls report, job openings data, and retail sales data in coming weeks all could provide clues on whether soft consumer data filters into the "hard" numbers, though no single month is a trend. Any uptick in weekly initial jobless claims or continuing claims is also worth noting. Even if the December jobs report headline looks solid, investors should pay attention to wages and the types of jobs that led growth. If service-oriented, lower-wage jobs keep growing at the expense of higher-paid ones, as appeared to be the case with November's jobs data, it could tighten wallets.

U.S. Treasury yields have long enjoyed relatively large premiums to those in Europe and Japan. That gap is narrowing, weighing on U.S. Treasuries and the dollar. "Central banks in the rest of the world are leaning more hawkish, while the Fed rate cutting cycle isn't over," said Michelle Gibley, director of international equity research and strategy, SCFR. Economic growth has held up better than expected in Canada and rates are on hold for now. In December, a European Central Bank (ECB) board member said she was comfortable with investor bets on a hike in 2026, and the Bank of Japan (BOJ) hiked rates earlier this month. "All this together could keep downward pressure on the dollar and boost international stock returns," Gibley said. It also threatens to draw money away from U.S. assets and into international ones, which would likely benefit from higher rates overseas. When this happened in mid-2024, it caused a sell-off for info tech stocks, though the set-up now isn't similar. Back then, speculative traders had a large bearish position in the yen that quickly reversed, which isn't the case today.

What's next? A weak dollar has the potential to reduce earnings for foreign companies that have a high percentage of sales and earnings generated in the U.S. However, the soft greenback, which fell more in December after a weak November jobs report, could provide tailwinds for major U.S. tech and materials companies that have a high percentage of overseas sales.

Washington worries lie directly ahead and could have a negative Wall Street impact. The autumn government shutdown took over a month to resolve, and issues behind it haven't gone away. Another shutdown looms at the end of January if Congress can't make progress on the government funding bills, and investors will have fresh memories. A second shutdown could also throw the collection of jobs, inflation and other economic data back into chaos, potentially damaging U.S. credit ratings, scaring investors away from U.S. assets and sending yields higher. Another outstanding D.C.-related question is the Supreme Court's pending decision on President Trump's attempt to fire Fed Governor Lisa Cook for alleged financial improprieties that she's never faced formal charges over. The Court will hear oral arguments in the case in January, with a ruling expected by mid-2026. A legal victory for Trump could undermine confidence in the Fed's independence, another possible weight on Treasuries. Fed Chairman Jerome Powell's term ends in May and the president has said in interviews that he wants to be consulted on interest rates by Powell's successor. "There is a risk premium being built into the market for weakening the Fed's independence," said Kathy Jones, chief fixed income strategist, SCFR.

What's next? Markets will be watching carefully the president's choice for Fed chair and the Supreme Court ruling on Cook. Investors should be on the lookout here for posts from Schwab's Mike Townsend, managing director of legislative and regulatory affairs, on maneuvering to avoid a shutdown and other policy issues that could impact the markets.

Despite all these concerns and many others that might hobble the markets, the path of least resistance for stocks still appears higher heading into 2026, in part because the economy is growing and earnings have been and likely will remain solid. While it's prudent to stay aware of potential issues, it's also worth considering pockets of potential strength.

Transports and small-caps—traditionally seen as leading indicators—both rallied toward the end of the year after trailing the broader market for much of 2026. Neither development is truly a trend, but if this strength continues, it could indicate faith that the economy can grow and provide better job prospects. Which, in turn, might help keep consumer spending on track. Cyclical sectors might also see a positive impact from stimulative fiscal policy—including tax breaks that take effect in 2026—which could give consumers and businesses a boost.

As of late December, a market rotation out of info tech brought the AI trade to a screeching halt. Whether that persists in 2026 will be a major area of focus, especially as analysts predict muted growth in technology earnings in 2026 versus 2025 (from 27% vs. 25%) and a decline of earnings growth in communication services (from 20% to 10%). These two sectors house five of the Magnificent Seven stocks and represent a large percentage of the AI "hyperscalers" and chip makers. At the same time, industrials, materials, energy, and utilities are four sectors analysts expect to see expanded earnings growth from next year. Does this mean the expansion of data center building and the need for additional capacity are priced into these earnings estimates? Time will tell, but this could signal that another phase of the AI buildout—the construction phase—is well underway and could be an additional driver of growth in 2026. 

What's next? Any signs that the Fed is prepared to cut rates sooner than expected would likely give small caps and transports a boost, along with so-called cyclicals like materials and industrials involved in AI construction. Lighter increases than expected in November's Consumer Price Index (CPI) sent yields lower as investors began thinking a rate cut could come sooner if such data persist. As of late December, market participants anticipated two to three 2026 rate cuts, more than the one penciled in by Fed officials in their latest "dot plot." Monitor the CME FedWatch Tool for any signs of changing trends, and keep an eye on skyrocketing copper prices, a good barometer of industrial demand.

If the Fed's December quarterly projections are right, the economy might glide along quite nicely in the coming years. Fed policymakers offered an upbeat view of economic metrics, raising the median projection for 2026 gross domestic product (GDP) growth to 2.3% from September's projected 1.8%, keeping the 2026 unemployment projection steady at 4.4%, and slightly lowering 2026 core Personal Consumption Expenditures (PCE) price growth to 2.5% from 2.6% in September. To sweeten the pot, the Fed also pencils in another rate cut at some point in 2026, while futures trading indicates two to three cuts. Cumulatively, the past cuts could accelerate economic growth in coming months, though they haven't done much to bring down long-term yields or mortgage rates. In his December press conference, Fed Chairman Jerome Powell said economic activity is "expanding at a moderate pace," and consumers appear "resilient." He added that the housing market remains weak.

What's next? Lower rates haven't brought mortgages down, though home builders spent the last year or two providing discounts to get people to buy. The weekly MBA mortgage applications report, released on Wednesdays, is a good near-term indicator of housing demand, and consumer sentiment surveys and the Fed's Beige Book might provide clues as well on the impact of lower rates.

It's difficult to embrace a highly valued stock market if corporate earnings struggle. Luckily for bulls, that isn't the case. Third-quarter 2025 earnings growth of around 15% for S&P 500^® index companies nearly doubled pre-quarter expectations, driven by big tech but also by sectors like financials, real estate, materials, and industrials. "Cyclical" industrials and materials saw third-quarter earnings improve markedly from earlier in 2025, and both are expected to remain strong throughout 2026. Data and analytics firm LSEG's I/B/E/S Estimates put full-year S&P 500 earnings growth of 14.6%, up from 13% in 2025. "Amid the AI hype and mega caps' increasingly large weight in the indexes, a less-discussed aspect of the market's performance this year has been the lack of multiple expansion in the second half of the year," said Schwab's Gordon and Sonders in their 2026 outlook "The forward earnings per share estimate for the S&P 500 has made successive all-time highs since the low earlier this spring. Taking a back seat has been the forward price/earnings (P/E) ratio. In other words, the E has been doing the heavy lifting, which has put downward pressure on the P/E. In general, an earnings-driven market tends to be healthy."

What's next? Earnings, of course. The season begins in mid-January with big banks. Key tech firms start reporting later in the month. Nvidia (NVDA) likely shares results in mid-February. Fasten your seatbelts.