The Watchdog – Home and Abroad
— Scott B. MacDonald, Ph.D.
January 5, 2026
Summary: We are cautiously optimistic about markets and the US economy for 2026, but there are plenty of downside risk factors. While many investors are focused on AI, the US intervention in Venezuela signaled that geopolitical risk is a major factor for the year ahead. We are witnessing a major shift to power politics, which has implications for markets. You can expect to see efforts to uphold a rules-based international system, which makes economic statecraft a part , both local and national, of our forecast for 2026.
Looking behind and ahead.
Abroad - Geopolitical concerns are likely to loom larger in 2026 than last year. Considering the Trump action in Venezuela and Russia in Ukraine, other countries may feel emboldened to conduct the same actions. The words of political scientist Hans Morgenthau ring true of where we are today: “International politics, like all politics, is a struggle for power.” Why negotiate when actions get you want by force? We are decidedly in the age of power politics. The geopolitical maps are being rewritten adding to market uncertainty. The following are worth watching in 2026:
• The Russo-Ukrainian War is likely to drag on, as Putin appears to have little inclination for stopping short of larger territorial gains.
• Venezuela is just starting what is likely to be a rocky and not necessarily assured transition to democracy. The Monroe (“Donroe”) Doctrine is in action and external actors should be aware of that.
• The crisis in Iran in which the theocratic regime is facing widespread opposition could have major implications for the balance of power in the Middle East and oil markets.
• Considering a longstanding claim that Taiwan is a breakaway province and the Trump administration’s action in Venezuela, Beijing could be emboldened and pull the trigger for an invasion.
• Cuba’s economic collapse could leave a new crisis on the US doorstep.
• Does the Trump administration feel emboldened to take control of Greenland, which would certainly upend NATO and roil global markets?
Back home in the US…
In 2025, the US economic landscape was dominated by the Trump administration’s erratic tariff juggernaut, inflation pressures, softening labor markets, a White House-Fed tussle over interest rates, and a historically long government shutdown. At the same time, the AI revolution bedazzled Wall Street, sucking in massive amounts of investor cash, private equity blossomed, lower energy costs helped contain price pressures and the White House touted the massive wave of new investment heading into the country to Make America Great Again. Geopolitical concerns were ultimately brushed off as so much background noise. And the rising ocean of red ink around the US fiscal deficit and public sector debt faded like secondary characters in a Broadway drama.
Looking into 2026, Wall Street mavens are almost giddy that the new year will be better than 2025 – stronger growth, robust corporate profitability based on greater productivity from AI, higher equity markets and bigger private equity deals. Powering this rosy outlook is a combination of deregulation and lower taxes embodied in the One Big Beautiful Bill Act, hopes that manufacturing will grow again, consumers feeling better about employment prospects, a more dovish Fed (with two rate cuts expected), continued low oil and natural gas prices, and greater policy continuity. Real GDP growth will probably top 2.0%. The outlook is rosy.
But we have our concerns.
Tariffs are not a settled matter. The Supreme Court can still overturn the Trump administration’s tariff program and deals have not been fully finalized with Canada, Mexico, Indonesia, and the European Union, and China remains an ongoing make-a-deal gambit.
While larger US companies have been able to absorb some of the tariff costs and game different levels of country tariffs, small and medium-sized US businesses lack that capacity. Uncertainty fueled by tariffs and a nervous lower income consumer are dominant themes. Bankruptcies are on the rise. Data from Epiq Bankruptcy Analytics put small businesses declaring bankruptcies at more than 2,300 year-to-date through mid-December, a 10% increase from the period in 2024. Why do we care? According to the US Chamber of Commerce, small and medium businesses account for around 44% of US GDP.
Inflation is likely to remain a challenge and probably won’t hit the Fed’s inflation rate target of 2.0%. A considerable amount of stimulus is being pumped into the economy through the One Big Beautiful Bill Act. At the same time, there are going to be ongoing price pressure from tariffs, more rate cuts, and rising healthcare costs.
Private equity is a massive market, based on non-financial institutions making loans that in the past were made by traditional banks and in some cases taking active management of those companies. Assets under management (AUM) for private equity are estimated at around $11 trillion worldwide in 2023-2024. The combination of a White House more open to M&A activity and deregulation as well as a push to sell private equity products to retail clients (like 401Ks) means that there is a lot of capital looking for places to go. According to Bloomberg, private equity firms and other investors bought and sold at least $75 billion of US industrial and infrastructure assets in 2025, a record for data going back to 1998.
While private equity has a constructive role to play in financial markets, the sheer volume of capital involved and set to flow into it carries risks. First, transparency and disclosure are more limited in private equity markets, helping to obscure problems at struggling businesses like with First Brands with its sleight-of-hand finances. While large and sophisticated investors may be able to steer away from blowouts, the “democratization” of private equity could deal a crushing blow to smaller, less sophisticated investors. Second, the transparency issue also obscures the exposure banks have to the sector. In 2025 the US Federal Reserve stated: “Banks are lending to the same (non-bank financial institutions) including private credit vehicles that are providing the credit insurance, meaning that…some of the risk is actually not leaving the banking system as it appears.” All of this have a familiar feel to it, an echo perhaps of 2008? The risk may not yet be systemic, but with more capital flowing and deals looming size and scale are set to head in the direction of systemic risk.
AI’s bubble? As with private equity, the AI sector has seen a massive inflow of capital, dominated by the likes of Nvidia, Meta, Microsoft, and Apple. Anything AI-related has sucked in capital. Investors will be closely watching to see whether earnings will hold up. Corporate America has pumped a lot of money into the sector and wants to start seeing the results. Moreover, there is a menu of potential AI IPOs waiting in the wings, including SpaceX, OpenAI, and Anthropic. The risk is that if these IPOs do poorly, it could cause investors and corporate actors to pull back on AI investment. In turn, this could unsettle both institutional and smaller investors, in a sense providing the power to pull the yarn on the AI investment story sweater, causing it to unravel (for now).
While US labor markets will benefit from new projects coming home to the US, economic growth and a shrinking labor pool from deportations, they are increasingly facing tougher headwinds, especially from growing use of AI and robotics. Pesky humans want health insurance, time off and livable wages, all of which cost money. Not a problem. According to a Goldman Sachs study, productivity from AI will ultimately be around 20%-30%. The same report notes that there will be modest headcount reductions in the short term, 4% in 1 year but up to 11% in 3 years. The biggest losers will be white-collar positions in administration, customer support, legal and coding. Some new jobs will be created but the new jobs require training and most likely will not make up the gap of lost jobs, all of which feeds into affordability angst and reinforcing the K-shape in the US economy.
2025 was a tumultuous year. It looks like 2026 is going to be a repeat. Buckle up.
