Ebullient Markets, Anxious Investors: Why Diversification Still Matters in 2026

By Mark Armbruster, CFA

As we enter the New Year, stock market investors have a solid 2025 at their backs. The S&P 500 was up 18%, well above historical averages. In fact, it won’t come as a surprise to anyone that these types of aberrant, yet very positive, returns have become a trend. The S&P 500 has risen in all but two of the past 17 years. The compound annual growth rate has been a little over 13%, also well above historical averages.

The ebullient environment has Wall Street clamoring for more. In a recent Bloomberg survey of market watchers, all of them expect the market to continue moving higher in 2026. The average forecast is for a further 9% gain.

Certainly, there are reasons to be bullish. Corporate earnings, fueled by massive AI companies, continue to move higher. Economic data is not all positive, but GDP growth looks healthy, unemployment is holding at low levels, interest rates are declining, and inflation appears to be reverting toward the Fed’s long-term target of 2%. Not a bad backdrop to support further stock appreciation.

Yet, most of the people we talk with (who are not Wall Street strategists) are more nervous than enthusiastic. While there is plenty of good news to point to, there is the inconvenient fact that stocks trade at very high valuations. Never mind that AI stocks are growing like crazy or that their earnings compound at ridiculous rates every year. There is still no way to justify the price/earnings multiples or other valuation metrics that we are seeing today. That likely puts us into “bubble” territory. The problem is that bubbles can last a long time before popping, so the Wall Street strategists may be right about 2026. However, the bigger problem is that they can’t be right forever; past stock market periods with similarly lofty valuations always ended badly, which explains the investor nervousness.

During the 1990s dot-com bull market, many professionals argued that “it is different this time” and that we were in a “new economy.” They argued that unprecedented growth and productivity enhancement from the internet could justify the stock market’s huge run higher. They were right that the internet impacted all our lives and made businesses more productive. However, they were wrong that stock valuations didn’t matter. The internet transformed our lives and stocks still experienced a roughly 50% correction between 2000 and 2002. Tech stocks dropped much more and didn’t recover for more than a decade.

We’re hearing again today that AI is going to be transformative and that high valuations can be justified by the insane growth of the AI leaders. During trending markets, we sometimes forget that changes in markets are inevitable. The magnitude and the timing of market cycles are impossible to predict, but things certainly ebb and flow. Silver recently ran up from $30 less than a year ago to $76 today. That’s a fantastic return, but silver also went thirty-one years (from February of 1980 to March of 2011) with a total return of zero. It then went 14 more years (starting in May of 2011) without making a new high. Gold is another investor darling today that has had long runs with no returns, like the one from November 1980 to April 2006. Sure, commodities can be volatile, but those types of dry spells are not unusual even in more traditional investments. Staid government bonds outperformed risky stocks over the 30-year period from December 1980 to November 2010. And, unfortunately, lost decades in the stock market have been all too common. They tend to happen just after periods of extreme stock market valuation, sort of like today. We experienced this in the 1930s, the mid-1960s, and, of course, the 2000s. Will it be different this time? Can stocks tread water forever regardless of how they are trading?

The truth is no one knows. Maybe it is different this time, but probably not. And there are far bigger questions beyond that. Will tariffs cause stagflation? Will we see renewed growth because of AI? Will we see a short, steep bear market and then a quick rebound? Will the market go down and stay there for many years? It would be nice to know these things, but they are impossible to know. However, we can account for them all by diversifying.

The idea of diversification is a quaint notion these days. After all, you got rich over the past 5-10 years by being concentrated in U.S.-based, large company tech stocks. Why would it make sense to diversify beyond that? However, as we point out above, patterns don’t always persist, and an element of protection can go a long way. Diversification may leave some money on the table during runaway bull markets, but it historically has made up for it during the subsequent downturn. Small-cap value stocks and international stocks were drags on portfolio performance during the 1990s, just as they have been during the current bull cycle. However, they were invaluable tools for surviving the subsequent lost decade of the 2000s.

The good news is that despite “the market” trading at lofty levels, there are plenty of other asset classes and even pockets of the stock market that appear historically attractive.

The ultimate diversifier has always been bonds. Typically, when stocks head south in a big way, bonds provide a stable haven that you can draw funds from. However, nothing is universally true when it comes to the capital markets, and even bonds have times when they “don’t work”. That was true in 2022 when both stocks and bonds declined significantly. In that case, it was nice to have an allocation to alternative investments, which were up close to double digits. Non-stock asset classes can go a long way toward reducing overall portfolio risk.

Even within stocks, there is good opportunity for the future. Smaller companies in the U.S., value stocks, and international stocks all trade at valuations far below the largest U.S. growth stocks. If there is a sizable market rout, all of these could lose money, but a diversified stock portfolio will likely weather the storm better than one concentrated just in tech stocks.

So, investors are right to be nervous these days. However, nervousness is different than panicked. Even amid news of stock market highs and the potential for a future downturn, proven portfolio management techniques can go a long way toward keeping long-term financial plans on track.

For more information on Armbruster Capital’s investment management philosophy and approach, contact us via our website, call (585) 381-4180 or email us at info@armbrustercapital.com.

Disclaimer:

**Armbruster Capital Management’s views as portrayed in this post are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Investing involves risks, and the value of your investment will fluctuate over time, and you may gain or lose money.

Past performance is no guarantee of future results.