The U.S. economy continues to hum along despite all the headlines about “affordability,” tariffs, immigration, and actual or potential military actions across the globe. Fourth quarter Gross Domestic Product rose at a 1.6% annualized rate but would have been up 2.5% excluding the drag from lower government spending. The quarterly figures are comparable to the level of full-year growth.

Underlying economic indicators have been inconsistent. December retail sales were surprisingly flat after a robust November. For all of 2025, 3.7% growth in retail sales seems satisfactory until one realizes that growth is in the low 1% range once inflation is factored in. We remain in a bifurcated economy where the high-end consumer continues to spend, buoyed by strong financial markets and home prices. Lower income consumers have never recovered from the cumulative impact of several years of higher prices and subdued wage growth. Middle income consumers, even some in the upper middle range, have started to feel pinched as well.

The number of new jobs has trended downward all year, driven in part by a sharp reduction in U.S. government jobs. January started off fairly strong with 130,000 new jobs and a slight reduction in the unemployment rate to 4.3%. However, these estimates have not proven accurate for many years with subsequent downward revisions in 11 of the 12 months of 2025. While it might be tempting to blame government cutbacks, the negative revisions were worse earlier in 2025 than later.

The purchasing managers’ index from the Institute for Supply Management showed that manufacturing activity appears to have jumped in January. The index reached its highest level in 3-1/2 years, rising to 52.6 from 47.9 in December.

A Wall Street Journal panel of 74 academic and business economists forecast U.S. real GDP to grow 2.2% in 2026. The World Bank came up with the same forecast. Growth is forecasted to slow in the rest of the world, continuing a long-term trend. Japan grew 1.1% last year and the eurozone grew 1.5%.

Despite steady growth, the rate of inflation continues to edge lower. Over the past year, the Consumer Price Index rose 2.4%. With softness in the job market for much of the year and inflation coming down, the Federal Reserve cut interest rates three times in 2025. The consensus is for two rate cuts in 2026, one in June and another in the fall. Some economists believe that there will be three rate cuts.

One risk to the stock market this year is if the forecasted rate cuts don’t materialize. Rate cuts are like catnip for investors. There are economic reasons why interest rates affect stock prices, but it is the cumulative effect rather than just one cut. Rate cuts appear to be largely factored into investors’ assessment of stock prices, and you don’t want to be there when investors don’t get their catnip!

Treasury interest rates are also biased toward lower interest rates. The Two-Ten Spread, the difference between yields on 2-year and 10-year Treasury notes, is about 60 basis points. Economists differ on what is the normal spread, but 60 basis points are within the range of opinions. Widening spreads can be a warning sign of inflation worries. Narrowing spreads suggest worries over economic growth. An inverted yield curve, when investors accept lower rates for longer duration bonds, is a harbinger of recession. Watching Treasury rates tells us that the bond market economists are forecasting moderate growth and inflation that is well controlled.

Gold is one investment that has been particularly strong for quite a while. It is hard to value gold because emotions can run high, but dividends are nonexistent. It looks nice, and it has represented real money in most cultures for thousands of years. However, its current price is well above the cost of mining gold which is thought to be $2,000-$2,500 an ounce. Gold typically does well when there are inflation worries or concerns over geopolitical stability. Inflation worries are subdued, but there is a considerable degree of geopolitical instability. Bitcoin, sometimes also thought to be a safe harbor during periods of volatility, has declined 47% since reaching its all-time high last October. We tend to pay more attention to gold prices compared to Bitcoin which has been thought to be money for perhaps a decade.

Despite a strong earnings season so far, the U.S. stock market has experienced increased volatility especially following the February 3rd announcement of new plugins for Anthropic’s Artificial Intelligence Cowork product that could attempt to mimic work performed in the legal, financial, sales, and marketing fields. Investors have become concerned that many software companies, service providers, and processing companies might see their business models rendered obsolete by AI. This emerging technology will have unexpected impacts, both positive and negative, but the broad brush used by investors in recent weeks to presume that huge swaths of the economy will be rendered obsolete seems indiscriminate to us.

Many investors are worried about interest rates, inflation, affordability, uneven incomes, and politics. We are sometimes asked if the bull market is at risk because of high valuations or the market’s dependence on AI stocks. Bear markets are almost always accompanied by a recession. An inverted Treasury yield curve is one early indicator. The yield curve is normal, and most indicators point to continued economic growth, not a recession. The market typically sees a correction of 10% every year, and that remains possible for 2026. However, the gut-punch bear markets are accompanied by recessions and that doesn’t seem likely this year.

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