Wells Fargo sees US markets to washout in 2025, but rise in 26: here's why

Wells Fargo forecasts a "washout" for US stock market gains in 2025 due to tariff uncertainties and a potential economic slowdown, but projects new market highs in 2026 as the economy achieves a soft landing. Despite near-term volatility, the firm's analysis of historical data suggests that such periods often present opportunities for investors, with a median 18-month forward S&P 500 Index total return of 30% following periods of high volatility. For the remainder of 2025, Wells Fargo recommends focusing on quality allocations, favoring U.S. large- and mid-cap equities and developed markets while selectively adding exposure to AI and cyclical sectors during market pullbacks.

Analysis

Wells Fargo Investment Institute (WFII) projects a challenging 2025 for U.S. equity markets, characterizing it as a "washout" period with significantly constrained gains, primarily due to uncertainties surrounding tariffs and trade-policy negotiations. These trade frictions are anticipated to act as a "significant obstacle for market growth," potentially reducing consumer purchasing power and compressing corporate profit margins as businesses absorb increased costs, leading some companies to pause capital allocation towards growth projects. WFII foresees an economic slowdown, though not a full-blown recession, supported by "steady underlying support and looming tax policy extensions," with moderating job growth and real income gains temporarily pressuring consumer spending. "Front-loaded tariffs" and potential immigration policy risks are also flagged as factors that could elevate inflation and further dampen economic growth later in 2025, contributing to increased financial-market volatility. Despite this turbulence, WFII highlights historical data showing that periods of high volatility often precede strong market returns, citing a median 18-month forward S&P 500 Index total return of 30% following 10 past high-volatility periods, suggesting investors should "follow the lesson of history and lean into equities." The institute believes that without a recession, the risk of further equity-market downside beyond the lows seen in April 2025 is limited. Corporate earnings are expected to be squeezed in 2025 by tariffs, forcing companies to adapt, but the outlook for 2026 is more optimistic, with the firm forecasting new market highs as the economy achieves a "soft landing." For the balance of 2025, WFII recommends focusing on "quality allocations," favoring U.S. large-cap and mid-cap equities over small-cap options, and developed market equities over emerging markets, supported by an anticipated "resilient dollar through 2026." They also advise selectively adding exposure to Artificial Intelligence and reallocating from defensive sectors like consumer staples to more cyclical sectors such as energy, financials, communication services, and information technology when market pullbacks offer opportunities.

Key Decisions for Investors

• Investors should anticipate heightened market volatility and constrained gains in the US equity market for 2025, primarily driven by tariff uncertainties and a potential economic slowdown, and consider maintaining a focus on quality U.S. large and mid-cap equities.
• Given historical precedents where volatility created buying opportunities, consider strategically adding to equity positions during market pullbacks, particularly in developed markets, while being prepared for a potential "washout" phase before an anticipated stronger market in 2026.
• Monitor corporate earnings closely for signs of adaptation to cost pressures and look for opportunities to reallocate capital from defensive to cyclical sectors, including AI, energy, financials, communication services, and information technology, on market weakness, aligning with the expectation of a "soft landing" and market recovery in 2026.