Meet the 2 Words That Could Define 2026 Stock Market Returns

With less than two months left in 2025, the S&P 500 (SNPINDEX: ^GSPC) is within striking distance of gaining over 20% for the third consecutive year, a streak that hasn't happened since the late 1990s ... before the dot-com bubble burst.

As prices outpace earnings, some investors may be wondering if they should keep buying stocks at all-time highs or shift their investment strategy.

Here's why 2026 could be a wildcard year in the stock market with two words that will drive its returns.

Image source: Getty Images.

The narrative that will define 2026

This past spring, investors were spooked by tariffs. Initially fearing the worst, the market tanked on fears that a full-blown trade war would erode corporate profits. The sell-off didn't last long, and within a few months, the major indexes were back at all-time highs and have since built on those gains as sectors like tech, communications, and industrials led the way.

With this backdrop, the two words that will define next year's stock market returns are "what if?"

What if there's a slowdown in artificial intelligence (AI) spending, a recession takes hold, or interest rates remain elevated for longer than expected?

What if consumer spending becomes even more strained, credit risk increases, and the housing market remains bogged down by high mortgage rates and home prices?

What if the trade war heats back up and foreign rivals challenge U.S. tech giants?

Paying up for quality companies

"What if" always plays a role in the stock market, but its impact will be outsized next year due to stretched valuations. The more a company's valuation is based on bullish expectations, the more "what if" speculation creeps in. Investors can mitigate this risk by asking several questions in advance.

Take Nvidia (NASDAQ: NVDA). The company's market cap briefly surpassed $5 trillion, while it was worth less than $500 billion a few years ago. Now, Nvidia and a handful of other growth stocks that I call the "Ten Titans" make up 40% of the S&P 500. One weak quarter or a slowdown in AI spending from key customers could lead investors to question if Nvidia really deserves to trade at 43.1 times forward earnings.

Nvidia's upward climb has been extreme, but so has its earnings growth. Due to its size, it will be much more challenging for the company to sustain this earnings growth unless key customers ramp up their spending even further. But that would depend on their own AI monetization. For example, if OpenAI delays or reduces its $300 billion deal with Oracle, then Oracle may slow the build-out of its multicloud data centers, which would mean fewer chip orders from Nvidia, Broadcom, and Advanced Micro Devices.

The key to navigating a stock market at all-time highs isn't to smash the sell button and run for the exits but to find companies that are so good they can justify a premium valuation. Or in other words, find companies that can perform well over the long term, even during periods when investor fears and uncertainty are high.

A big mistake is to assume that just because many growth stocks are expensive, none of them are worth owning. A better approach is to accept that growth stocks are expensive and to be more selective, owning only high-conviction companies you would be willing to stick with even if their near-term results are volatile.

Investing in companies with less uncertainty

Companies whose future earnings potential is more certain aren't as impacted by the "what if" risk. Take Coca-Cola (NYSE: KO), for example.

It's no surprise that Coke roared to an all-time high in April during the height of the tariff-induced sell-off. Coke is a massive company with a global footprint, but its business model is resistant to macroeconomic changes.

In recent years, Coke has further diversified its beverage lineup to include more non-soda categories, such as energy drinks, sparkling water, tea, coffee, and even lactose-free Fairlife milk and protein drinks. Coke has excellent pricing power due to its brands, a highly efficient supply chain, and global brand recognition. Coke's supply chain includes bottling partners that manufacture, package, merchandise, and distribute its branded beverages.

These qualities reduce the potential impact of "what if" on Coke's earnings. Even in today's highly challenging operating environment with cost pressures and pullbacks in consumer spending, Coke is still generating organic revenue growth and higher earnings when so many other consumer staples companies are producing poor results and seeing their stock prices fall to multiyear lows.

Navigating an expensive market

With 2025 nearing its end, now is the perfect time for investors to conduct a portfolio review. The first step is to ensure that premium-priced stocks can justify their elevated valuations. This could come from a combination of factors, such as a strong balance sheet, industry leadership, a diversified business model, or growth potential so impeccable that you don't mind paying up for the stock.

It's also a good time to update your watch list by including stocks you would love to buy if they weren't priced for perfection. Even the best companies can get dragged down by a broader market sell-off for reasons unrelated to their underlying investment thesis.

And finally, it would be a good idea to ensure your portfolio isn't overly concentrated in just a handful of themes, such as betting on just one link in the AI value chain. Owning high-conviction growth stocks across a variety of industries can help reduce your risk exposure.

One of the most common mistakes in investing is to accidentally take on more risk than you're comfortable with. So if you find your portfolio is overly concentrated in premium-priced stocks, it may be a good idea to mix in some value stocks like Coca-Cola that can generate solid results and pay growing dividends, even during unfavorable market conditions.

Daniel Foelber has positions in Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Nvidia, and Oracle. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.