The relentless surge of the artificial intelligence (AI) trade has propelled global stock markets to unprecedented heights this year. However, as December unfolds, a traditionally strong month for equities, investors find themselves in a state of uncertainty. Conflicting signals about the health of the U.S. economy are creating a fog, leaving stocks in limbo just ahead of a crucial Federal Reserve interest rate decision scheduled for next week.
Mixed Economic Signals Cloud the Fed's Path
The data painting the picture of the world's largest economy is anything but clear. On one hand, a key benchmark reading from the Institute for Supply Management (ISM) showed activity in the vital services sector expanded in November at its fastest pace since February. Input prices also fell the most since March 2024, a positive sign for the sector. Yet, this strength is countered by persistent weakness. Employment within the services sector contracted for a sixth straight month in November, mirroring a concerning report from payroll processor ADP.
The ADP report indicated a net loss of 32,000 private sector jobs last month. Furthermore, wage growth for both job-stayers and those switching roles has slowed significantly compared to last year's levels. The official jobs report from the Bureau of Labor Statistics, typically a market-moving event on the first Friday of the month, has been delayed until December 16 due to the recent government shutdown. This data blackout forces the Fed to rely on private-sector readings and anecdotal evidence as it calibrates its policy meeting on December 10 and its forecasts for growth, inflation, and unemployment.
Mark Malek, Chief Investment Officer at Siebert Financial, emphasized the consumer's pivotal role, stating, "Consumption isn't just one of many factors in GDP … it is the factor, accounting for nearly 70% of all economic activity. When the consumer wobbles, the economy wobbles."
The Earnings Challenge for Lofty Market Valuations
The market's spectacular run, largely fueled by AI enthusiasm, now faces a fundamental test: corporate earnings. For stock valuations to be justified and for the rally to sustain into 2026, robust profit growth is essential. Data from LSEG suggests investors are betting on collective profits for the S&P 500 benchmark to rise by 14.6% in 2026, following an estimated 13% climb this year. If this forecast holds, aggregate earnings would reach $309.28 per share.
Major Wall Street institutions, surveyed by Barron's, project the S&P 500 could rise to around 7600 points by the end of 2026, up from its close at 6850 points on Wednesday. This would place the index's price-to-earnings (P/E) ratio at a lofty 24.5 times, well above its 10-year average of around 20 and its current multiple of 23 times. However, these optimistic earnings forecasts are vulnerable to a cautious consumer and a softening labor market, especially if inflation remains stubborn.
"Earnings will do the heavy lifting next year," said Savita Subramanian, head of U.S. equity & quantitative strategy at Bank of America, who forecasts a more conservative S&P 500 target of 7100 points for end-2026. "But we also worry about the tension between AI taking jobs versus consumption remaining resilient in 2026."
Consumer Caution Emerges as a Key Risk
Early warnings from the retail sector are already flashing. Department store chain Macy's cautioned investors on Wednesday about expecting soft demand from low-income shoppers during the critical holiday season. This shift in consumer behavior is also reflected in the contrasting fortunes of discount retailers and value-focused giants. Dollar Tree issued a better-than-expected outlook, while Walmart's stock hit a record high, signaling investor belief that consumers will prioritize value over discretionary spending.
Bret Kenwell, a U.S. investment analyst at eToro, summed up the prevailing anxiety: "There's plenty of concern right now for the state of the U.S. consumer. While this group has buoyed the economy over the last few years, persistent inflation, falling confidence, and a cooling labor market has investors anxious."
While the potent combination of anticipated Fed rate cuts, the AI investment boom, and fiscal stimulus is expected to support markets, repeating the recent run of near-20% annual gains will be far more difficult if unemployment rises and consumer caution deepens. The market's next move hinges on whether corporate profits can grow into their expensive valuations, a task made harder by the economy's mixed messages.
