Franklin Templeton stays moderately positive for 2026, US GDP growth expected at 2.5%
In a recent economic update, Chris Galipeau, Senior Market Strategist at the Franklin Templeton Institute says that the outlook for 2026 is moderately positive, with GDP growth in the US expected at 2.5%, supported by resilient consumer demand and potential rate cuts, though risks remain from the ongoing Middle East conflict and higher oil prices.
“Inflation is relatively stable despite rising short-term expectations, and the US dollar is expected to remain broadly flat. The outlook for US equities is constructive (with an S&P 500 target of 7,000–7,400), with opportunities in small caps and emerging markets, although volatility and performance dispersion are likely to persist, favouring active management,” he notes.
“In fixed income, the focus is on yield through short-duration bonds and credit, with municipal bonds appearing attractive, while investor sentiment is becoming more cautious but not yet at extreme levels.”
He details the outlook across macro, equities, fixed income and sentiment below:
Our forecast for 2026 real gross domestic product (GDP) growth is 2.5% (based on our Global Investment Management Survey[1]), which is above the Federal Reserve (Fed) forecast of 2.3% and the Wall Street consensus of around 2%. The main drivers of our GDP forecast are the continued capital expenditure (capex) spending by big technology firms, a resilient consumer (Delta Air Lines CEO Ed Bastian discussed both higher demand and revenue in the quarter1) and expected higher tax refunds in 2026 relative to past years, not to mention the possibility of future interest-rate cuts.
The duration of the current Middle East conflict is the primary risk to our forecast. Higher oil prices resulting from the conflict work like a tax on the consumer, and the negative impacts of higher oil prices will broaden over time.
We expect the Fed to cut rates twice in 2026 and core personal consumption expenditures (PCE) to remain stable in the 2.5% to 3.0% range. The last tick for core PCE data came in at 3.1% for January. The U-3 unemployment rate was 4.4% for February, just off the recent high print in November of 4.5%, which was the highest level since October of 2021. Additionally, last week the Producer Price Index (PPI) data was hot and probably reflects some tariff pass-through.
The conflict in the Middle East, should it persist and drive oil prices higher for longer, could put the Fed in a box with respect to its dual mandate.
Inflation expectations have moved up in the near term. One-year inflation breakeven rates are now 5.10%, an alarming move to say the least, although it is worth adding that there is a first-quarter seasonal component that has historically affected the data. No doubt, higher oil and natural gas prices are driving some or even all of this move. Two-year breakeven rates are 3.32%. Five-year breakeven rates are 2.68%. These numbers represent the bond market pricing annualized inflation expected over the coming one, two and five years. The shorter-term numbers indicate concerns, certainly, but the longer-term, five-year number is still anchored.
On the currency front, we think the US dollar will be essentially flat for the year despite the recent volatility. The US Dollar Index (DXY) last week traded at US$99.17, which is at the high side of its 11-month range, defined as $96 to $100. Many investors are concerned about the US dollar losing value, and some believe the dollar has recently weakened materially, but the fact is that the US dollar is at the same level today as it was in April of 2025 and higher than it was in early July of 2025, late September of 2025 and mid-January of 2026.
Equities
We are constructive on US equities and have established a target range of 7,000 to 7,400 for the S&P 500, based on expected earnings-per-share growth of 8% to 13% year-over-year (based on our Global Investment Management Survey[1]). We don’t expect this current geopolitical conflict to impact our outlook unless oil trades north of $100 and stays there for months. We expect high levels of volatility to persist in the near term.
Right now, this tape feels like death by a thousand paper cuts. We are held hostage to the situation in the Middle East and expect to be in this pattern until an off ramp comes into view. Let’s look at year-to-date (YTD) performance. Some of this might come as a surprise. Through the close of March 19, 2026 the S&P Midcap Growth Index was up 5.05%, the Russell 2000 Value was up 3.43%, the S&P Midcap 400 Index was up 2.29%, the Russell 1000 Value Index was up 2.13%, the S&P Equal Weight 500 was up 0.97% (the Equal Weight Index is a measure for the average stock, which means the average stock is up), and the Russell 2000 Index was up 0.79%. That’s the good news. On the downside, the Magnificent Seven basket (the stocks of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) was down 9.46%, the Russell 1000 Growth Index was down 7.87%, the S&P 500 Index was down 3.23%, and the Russell 1000 Index was down 3.16%. The downside appears manageable for diversified portfolios but is probably painful for anyone not diversified. The dispersion in returns sets up an attractive environment for active stock pickers, in my view.
Performance outside of the United States for YTD to last week, the MSCI Latin America Index was up 7.37%, the MSCI Emerging Markets Index was up 2.02%, and Japan (Nikkei 225 Index) was up 2.06%. The MSCI Europe Index was down 3.80% and India (Nifty 50 Index) was the laggard, down 14.72%. All of the international return data is in US-dollar terms.
Our outlook for forward earnings growth makes us bullish for US small-cap stocks and emerging market (EM) equities.
Let’s talk about where we are right now and how to deal with this conflict and the volatility it is creating. It’s time for discipline over emotion; it’s time to have a plan. If you have cash to put to work, keep watch on the S&P Volatility Index (VIX). If the VIX closes above 30 on a weekly basis, I think it’s probably an attractive time to dollar-cost average into equities. This is step one.
Since 1990, when the VIX closed at 30 or higher on a weekly basis, forward returns for the S&P 500 were positive. Ranking three-month forward returns for those periods, the median was 6.85%, and the hit rate was 80.28% for positive returns. The six-month median forward return was 15.15%, and the hit rate was 80.28%. The one-year median forward return was 23.46%, and the hit rate was 88.57%. Again, favor discipline over emotion.
Similarly, if market movements get out of hand, and the VIX index closes over 50 on a weekly basis, in my playbook it becomes time to be even more active. This is step two. Rather than dollar-cost averaging, my approach is to buy quality stocks on price weakness, even baskets like the Magnificent Seven. In the periods since 1990 when the weekly VIX closed above 50, the median forward return one-year was 24.06%, with a 100% hit rate. Again, I emphasise discipline over emotion.
Consider the “Rule of 16” as a forecasting tool to help gauge the magnitude of potential price movements when the VIX is elevated. The calculation is (VIX level/16) = likely price movement in percentage terms. A VIX reading of 32 (32/16) = 2% movement.
At the bottom line, our Institute believes it’s best to have a diversified equity playbook including large, mid, and small-cap exposure in the United States with a balance of growth and value. The same can be said for ex-US equity exposure. We favor positions in EMs and developed international markets. To act on the broadening theme, consider reducing concentration and diversifying portfolio exposure. The VIX index parameters described above can be helpful for deciding further action.
Fixed income
We expect US 10-year Treasury bond yields to trade in a range of 4.0% to 4.25% during 2026. Last week, the yield rose above the high side of that range, to 4.29%. The two-year Treasury yield discussed in the Macro section also punched above its range, trading at 3.85% at the end of last week. The US yield curve has flattened recently, with the two-year-to-10-year spread falling to 45 bps. We expect bull-steepening of the yield curve in 2026.
We expect short-duration fixed income mandates and corporate credit to outperform cash during 2026. Considering our views on US 10-year Treasury yields, we do not expect duration to be a significant driver of total return this year. Rather, all-in yield capture seems to be the play.
Credit spreads have made big moves in the last week. Investment-grade (IG) spreads (one-year/three-year option-adjusted spreads, or OAS) are 64 bps over Treasuries. High-yield (HY) spreads, as proxied by the Bloomberg US Corporate HY OAS, reached 306 bps over Treasuries in the past week. Corporate fundamentals appear healthy to us, although there is stress in the system now.
Historically, when IG spreads trade at 200 bps over Treasuries, forward returns for the Bloomberg US Aggregate Index have been positive over the coming three, six, nine, and 12 months. The spreads have not risen to that threshold, obviously, but if they reach that level, this historical data suggests it may be an attractive time to invest. Similarly, when HY spreads trade at 600 bps over Treasuries, forward returns have been positive three, six, nine and 12 months out. Again, markets are not at that point, but analysing this data offers some historical context.
We are bullish on municipal bonds again this year and find taxable-equivalent yields to be attractive, along with robust fundamentals. Importantly, the increased supply that hit the marketplace in 2025 has run its course for now, and muni bonds have been performing well since last August. We think this positive trend can continue.
Sentiment
The percentage of bullish investors in the latest AAII Investor Sentiment survey dropped to 30%, down two ticks from the prior week’s reading. The percentage of bearish investors rose again and is now at 52.0%, up six ticks from the prior week.
Neither of these readings is at an extreme, but sentiment is growing more cautious by the week.
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