Another Market Milestone

The stock market marked another major milestone last week when the Dow Jones Industrial Average (Dow) surpassed 50,000 for the first time. This follows the S&P 500 surpassing the 7,000 milestone just over a week ago. We’ve come a long way since the 30-stock blue-chip index was created nearly 130 years ago and had an initial value of 40.94. The Dow is an odd index by modern standards. First, it is focused on just 30 companies, which presents a narrow view of what is happening in the domestic market – especially when compared with other popular indices like the S&P 500 (500 of the largest companies by market capitalization) or the Russell 2000 (2000 of the smallest companies by market capitalization). Second, the Dow is a price-weighted index rather than a market-cap weighted index. The issue with price-weighted indices is that a stock’s price – not the size of the underlying company – determines its relative importance in the index. For example, Goldman Sachs, which has a market capitalization of $280 billion, is currently ~11% of the index. In contrast, Apple’s market capitalization exceeds $4 trillion but accounts for just 3.5% of the index. So, while the Dow is still one of the most commonly quoted indices, it fails as a good measure of what is happening in the broader context of the domestic market.

The first five weeks of 2026 are a great illustration of this. Year-to-date, the Dow has gained 4.4%, an impressive start to the year compared to the S&P 500’s 1.7% gain. However, most investors’ stock market exposure likely includes an S&P 500 component, while very few have assets allocated to the Dow. Even the S&P 500, with its large and diverse set of components, doesn’t tell a complete story of the market in 2026. Small-cap stocks have surged past their large-cap counterparts, with the Russell 2000 gaining nearly 8% over the same period. The rally in smaller companies has investors and strategists wondering if the group might finally get its day in the sun after underperforming large-cap stocks by a wide margin over the last decade.

Many strategists have argued that the outperformance of small caps is long overdue given the group’s more attractive valuation throughout the last several years. However, the market has been dominated by large-cap growth stocks because the growth they’ve been able to generate has really been that good. S&P 500 earnings have grown more than 10% per year over the last decade as large companies have taken market share and seen their profitability rise to record levels. The last few years of that story have been underpinned by technology stocks and surging spending on artificial intelligence (AI).

Now, investors aren’t sure that the massive investments in AI that have been powering earnings (and in turn the market) higher, will generate the necessary return to keep the party going. If large-cap stocks report disappointing earnings in the coming quarters, we could see valuations compressed as investors alter their expectations. At the same time, anticipation of lower interest rates, a stable economy, and attractive valuations have encouraged investors to move into smaller companies. The market action of the first five weeks of the year is a reminder that while a handful of companies or indices garner the bulk of investor attention throughout the year, context is important. Most investors’ portfolios should be broadly diversified – that includes a reasonable allocation to small-cap stocks – and should probably care less about what happens with the Dow and more about what happens in their portfolio.

Speaking of earnings, the fourth quarter 2025 earnings season is over halfway through, and results so far have been strong. Nearly 60% of the S&P 500 have reported results and more than 75% of those companies have beaten earnings expectations. The expected earnings growth rate for the quarter is tracking toward 13%, which would mark the fifth consecutive quarter of double-digit growth. Based on consensus expectations, the S&P 500 is trading at 21.5 times forward earnings. This is above the five-year and 10-year averages of 20.0 and 18.8, respectively. The weighted average profit margin for the quarter is trending toward 13.1%, which would mark the highest net profit margin for the S&P 500 since FactSet began tracking the metric in 2009.

If investors want to achieve another market milestone in 2026 – say 8,000 on the S&P – then margins and valuations need to remain above historic averages and sectors other than technology need to continue to rally. The market’s recent volatility has been tied to a planned $600 billion AI spending surge by big tech companies in 2026. An investment of this magnitude, funded by just a handful of companies, is unprecedented. The sheer size of the investment has investors concerned that margins at these big tech companies will come under pressure as they forgo near-term profitability in pursuit of long-term market share gains. This decision has put investors on edge when it comes to mega-cap technology stocks, which explains the recent shift in interest toward small-cap stocks that should see improving margins in the coming quarters if interest rates decline.

If you watched the big game on Sunday, you likely noticed that many of the commercials were tied to artificial intelligence. The focus on AI reminded many of us of similar trends during the 2000s dot-com bubble and the 2022 crypto craze, when venture-funded startups flush with investor cash spent significant sums on advertising before reaching profitability. Just because a company chooses to spend big on advertising doesn’t mean it’s doomed to the fate many dot-com-era startups fell victim to, but it does draw a fascinating parallel. Competition among AI companies and their respective AI models is fierce, and while this probably isn’t a winner-take-all situation, there will likely be a shakeout period when less successful companies run out of funding and larger competitors win share. If a shakeout does occur, it will be at the expense of investors who funded the startups and the suppliers who have fewer customers to buy their products.

Looking ahead to this week, the fourth-quarter 2025 earnings season will continue, with 78 S&P 500 constituents scheduled to report. On the U.S. economic calendar, Wednesday brings the closely watched January employment report from the Bureau of Labor Statistics. The unemployment rate is expected to hold steady at 4.4%. On Thursday, the Labor Department will release weekly initial jobless claims for the week ended Feb. 7 and continuing claims for the week ended Jan. 31. On Friday, the Labor Department is scheduled to release January inflation data. Headline CPI is forecast to increase 2.5% from a year ago.

Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Market Commentary/Market