'Inflation will surprise to the downside in 2026': Why Wall Street expects juiced economy, stock gains this year

Investors may be “having a cake and eating it” in 2026, with Wall Street strategists predicting stock market gains driven by Fed rate cuts, tax incentives, and lower-than-expected inflation.

As Wall Street prepares for this week’s highly anticipated monthly Consumer Price Index report, which is expected to stay unchanged from the prior month at an annual increase of 2.7%, strategists are pointing to cheap oil prices and easing shelter costs as a sign that prices may be cooling.

“Our view is that inflation will surprise to the downside in 2026,” Longview Economics global economist and chief market strategist Chris Watling told Yahoo Finance last week.

It’s not all good news on the economic front. Last month’s employment report, released on Friday, showed the economy added fewer jobs than expected to cap a weak 2025.

But a cooling labor market gives the Federal Reserve reason to cut rates this year, which could push bond yields lower. That’s especially true if President Trump’s pick to replace Fed Chair Jerome Powell when his term ends in May shifts the central bank in a more dovish direction.

Lower yields mean cheaper borrowing costs, which can boost economic activity and keep corporate capital expenditures high.

“You could really get an economy pretty juiced as we go through this year, because you can have the capex, and you can have the sort of consumption starting to improve as housing fixes up and bond yields move lower,” Watling added. “This is what I call having a cake and eating it.”

Wall Street is already spotting “green shoots” as companies take advantage of the depreciation tax benefits from Trump’s One Big Beautiful Bill (OBBB) Act, signed into law in July.

“If you are a CFO of a company, and the OBBB allows you to get 100% depreciation for capex in one year … you will absolutely accelerate as much of your multi-year capex spend into 2026 as possible, or risk getting fired for missing those tax benefits,” Nomura Securities equity derivatives analyst Charlie McElligott wrote in a note last week.

Economic growth happens even as affordability challenges maintain a K-shaped divide, with the bottom half of consumers struggling to cover basic needs. In a nod to affordability ahead of the midterms, Trump recently criticized firms like Blackstone for buying single-family homes as investments, a hot-button issue for voters.

Read more: What is a ‘K-shaped’ economy, and what’s causing the divide?

Rents have started to ease after years of relentless growth. That’s one reason Goldman Sachs expects the Personal Consumption Expenditures (PCE) index to trend toward the Fed’s 2% target. The firm also noted that the one-time price bump from last year’s tariffs is fading, which should further ease inflation.

“Healthy economic and revenue growth, continued profit strength among the largest US stocks, and an emerging productivity boost from AI adoption should lift S&P 500 EPS by 12% in 2026 and 10% in 2027,” Goldman’s Ben Snider wrote on Wednesday.

The latest data shows worker productivity in the third quarter grew at its fastest clip in two years, as businesses spent heavily on AI and pulled back on hiring.

That productivity boost is expected to broaden the stock market rally, as the S&P 500 (^GSPC) and Dow Jones Industrial Average (^DJI) touched all-time highs last week. Materials (XLB), Industrials (XLI), Energy (XLE), and Consumer Discretionary (XLY) were some of the leading sectors as investors trimmed tech exposure.

“We’re producing a lot more with less people,” RCM chief economist Joe Brusuelas told Yahoo Finance on Friday, though he believes the full impact of AI is still a couple of years away.

Against that backdrop, strategists are watching for sectors and companies positioned to benefit from leaner headcounts and growing AI adoption.

“Pay attention to high human capital businesses — so let’s say finance companies, retail companies, consulting, accounting type businesses,” Clark Capital CIO Sean Clark told Yahoo Finance recently.

“Quality value companies are now starting to experience the benefit of this AI revolution, driving earnings, driving productivity, [and] driving margins higher,” he added.

However, some warn that if the labor market is replaced by AI too quickly, it could pose a sudden threat to the broader economy.

“We term it as the dark side of AI,” Tim Urbanowicz, chief investment strategist at Innovative Capital Management, told Yahoo Finance. Urbanowicz estimates that 15%-20% of the layoffs at the end of last year were related to artificial intelligence.

“If you start to see the jobs market or labor market starting to be replaced by AI in a major way, we think that becomes problematic,” he added.

Ines Ferre is a senior business reporter for Yahoo Finance. Follow her on X at @ines_ferre.

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