Written by: Phil Melville, Chief Risk Officer at Brighthouse Financial

2025 has been a good year financially overall. Looking first at the U.S. economy, U.S. gross domestic product (GDP) increased 4.3% on an annualized basis in the third quarter of 2025, up from 3.8% in the second quarter. The growth in the third quarter was driven by increases in consumer spending, net exports, and government spending, contributing 2.4%, 1.6%, and 0.4%, respectively. Imports declined again in the third quarter but had a smaller impact on the GDP results compared to the second quarter. Investment spending subtracted 0.1%. The Consumer Price Index (CPI) ticked up in September 2025 to 3% year over year, up from 2.9% in August.

In April 2025, asset markets fell after the Trump administration announced sweeping tariffs but rebounded sharply after tariffs were softened and some trade agreements were reached. The passage of the One Big Beautiful Bill Act (OBBBA) by Congress also helped to stabilize investor sentiment. In 2025, on a price basis, the S&P 500^® Index returned 16% while the Nasdaq-100^® Index and the Russell 2000^® Index returned 20% and 11%, respectively. Emerging markets performed strongly as well, returning 31% for the year. The Bolsa Mexicana was up 16% for the year, though down 3% in the fourth quarter. Developed markets outside of the U.S. have also performed well in 2025, aided by overall strong quarterly returns with the FTSE 100, CAC 40, and Nikkei 225 returning 6%, 3%, and 12%, respectively. Across the U.S. Treasury yield curve, the 3-month Treasury Bill rate fell 35 basis points to 3.67% while the 10-year Treasury was up 2 basis points to 4.18% in the fourth quarter. Also worth noting, corporate spreads have remained relatively tight throughout the year, signaling belief in a benign economic and market environment.

The consensus GDP growth estimate for 2026 is 2.1%, slightly higher than our internal 2026 estimate of 2%. We believe solid growth is supported by a consumer sector that accounts for almost 70% of U.S. GDP, with unemployment still relatively low at 4.4%, while household wealth grew by 9% year over year thanks to a strong stock market with disposable income growing by almost 5% year over year – that’s the good news.

The bad news is that surveys of consumer confidence show that the U.S. consumer is not happy, and this may be due in part to pressures that are building on both the labor and inflation fronts. There have been signs of weakness as job openings have dropped, the average duration of unemployment has increased, and wage growth has slowed. Kraft Heinz recently warned of the worst U.S. consumer sentiment they have seen in decades.¹ Amazon, Target, UPS, and others have announced large job cuts, with Amazon’s cuts of 14-30K jobs mostly comprising higher paying white-collar jobs.² Challenger, Gray & Christmas have tracked roughly 1M job cuts this year – up over 54% versus last year and the highest total since 2020, when over 2M job cuts were made.³ If the labor market weakens even more in 2026, spending will likely also fall and growth will drop as well.

We continue to believe there is also a risk of inflation being higher than expected in 2026 due to tariffs as companies pass price increases to end consumers. Though headline inflation unexpectedly slowed in November to 2.7% compared to 3% in October, the data indicates a sharp upswing in goods prices to a 1.4% year-over-year rate versus a negative rate several months ago. Other components of inflation are also moving higher or remain at a high rate; for example, services inflation in the last reading in November 2025 was at 3% year over year, but once again unexpectedly down from 3.5% in October 2025. Given the underlying data and looking ahead in 2026, the consensus estimate of 2.9% inflation is a bit too low, in our opinion, and our internal estimate is for inflation to run hotter at 3.2% year over year. There are three factors that could offset higher inflation. One factor is the softer labor market – as service costs tend to be sticky, a significant weakening in the labor market could lead to lower service inflation. Although this is not our base case, it’s something to monitor in 2026. The second factor is the noted deflation in China that could feed through to lower inflation of goods, even in the face of higher tariffs. The third factor is housing prices and rent costs, as real estate prices have softened and apartment supply has spiked, with more incentives being offered to renters.

Another risk to the economy we see is that profit growth is slowing. We take the broadest measure of profits across the U.S. economy, not just S&P 500 Index profits. What we’re seeing is a slowdown in profits to a roughly 4% year-over-year growth, down from a 6% rate earlier in the year. A slowdown in profits is usually met with cost cutting, which often means layoffs and could feed into a worsening labor market, as mentioned above. With large investments being made in artificial intelligence (AI) and AI-related infrastructure with little associated profit, the implication is that such investments must be funded with cash or debt. While the collective balance sheet of U.S. companies investing in AI is relatively strong and cash-rich, a slowdown in AI spending coupled with slowing profits could point to lower GDP growth.

Fortunately, a stable macroeconomic environment, despite the risks we see, should support solid asset market returns in 2026. We expect modest equity market returns in 2026 following a strong year in 2025, with the S&P 500 Index up about 14% year to date. Our internal estimate is for a more modest 5% return for the S&P 500 in 2026, while the consensus estimate is 7.3%. Historical returns provide no clear guidance on future returns, but there were three significant periods when the S&P 500 had double-digit positive returns for several consecutive years: 1942-1946, 1982-1986, and 1995-1999. Double-digit equity returns from 1995 to 1999 were followed by three consecutive years of negative returns from 2000 to 2002, as shown in the table below.

Looking at interest rates, the Federal Reserve (Fed) raised the federal funds rate 525 basis points from March 2022 to July 2023 and cut rates by 100 basis points in 2024. In 2025, the Fed cut rates by 25 basis points each in September, October, and December. The futures market is currently pricing in roughly two more rate cuts in 2026. These market expectations have been volatile due to uncertainty about inflation and economic growth. We expect that uncertainty to diminish somewhat in 2026. For year-end 2026, our internal estimate for the U.S. 10-year Treasury interest rate is 4.00% compared to the consensus forecast of 4.17%. We believe there is downside risk to this estimate of 25-40 basis points if the labor market and inflation downside risks we see materialize.

If equity market returns are positive in 2026, we expect investment-grade and high-yield credit spreads to remain range bound in 2026, reflecting a benign default environment. Of course, there are likely to be bouts of volatility as we have seen each year, but overall, we expect a stable economic and market environment for 2026, with noted possible risks from a weakening labor market, weaker profits, and higher inflation.

We believe the Nasdaq-100 Index is currently in a bubble due to the dominance of AI and technology stocks. The Nasdaq-100 had previously exhibited signs of a bubble, and that bubble burst in the stock market correction of 2022 as the Federal Reserve sharply raised interest rates. Unfortunately, the Nasdaq-100 has rebounded very quickly and is again exhibiting signs of being in a bubble. The parallels between the dot-com bubble of the late 1990s and the AI bubble of today are quite close. In both periods, there were numerous unprofitable companies with high-equity market valuations, an over-reliance on debt funding for key infrastructure spending on build-outs, and the use of off-balance sheets/nonrecourse debt for companies investing heavily in the new technology.

No one knows what will cause the Nasdaq-100 bubble to burst or when exactly it might occur, but given the correlation among equity markets, we do not think other markets will remain unscathed if the Nasdaq-100 Index drops sharply. We have previously seen 50% downturns in sharp market corrections, which puts the 20%+ correction of the Nasdaq-100 in 2022 into better perspective. Even a 20% drop in portfolio value could significantly hurt one’s potential retirement income if it happened early into retirement, as it could take several years – at least – to recoup the lost value. In a truly extreme bubble bursting such as what happened in Japan in 1991, the Nikkei took over 30 years to get back to its pre-bubble levels – a devastating impact on wealth. As such, having some downside protection on equity market exposure and/or rotating into fixed income assets before retirement would be a prudent measure given where we see equity valuations today.

The difficult debt dynamic is further impacted by two factors. First, the U.S. funds roughly 40% of its debt from foreign buyers. If those buyers lose confidence in the fiscal or monetary strength of the U.S., that will directly translate into a weaker dollar and higher interest costs. Second, the combination of tariffs and an aging workforce points to the possibility of higher inflation as discussed above.

Unfortunately, history shows that addressing high deficits and debt is not easy since there are only a few options for reducing debt: 1) default on it; 2) inflate it away; 3) grow out of it; or 4) pay it off. The U.S. opted for options two and three after debt spiked from World War II, using a combination of high real GDP growth and high inflation to shrink the debt to GDP levels significantly over the course of a few decades. The ability to use high real GDP growth seems more limited for the U.S. given a shrinking labor force due to aging, but perhaps there will be increased productivity from AI. Failing a productivity boom to boost growth, and assuming the U.S. would not default on the debt, that only leaves option two (i.e., inflation) and option four (i.e., paying off the debt) as the only viable options. Using inflation as a long-term strategy to address the U.S. debt seems quite risky given the multiple negative impacts discussed above.

As such, we believe the U.S. will be forced to pay down the debt by reducing budget deficits and perhaps even running budget surpluses. The only way to do that is by increasing revenues and cutting spending. Realistically, politicians are reluctant to cut spending, and over 100% of the U.S. budget deficit is on nondiscretionary items such as Social Security, Medicare, Medicaid, and interest on the national debt. We believe that taxes are likely to rise in the future because there is no other realistic choice. The current highest marginal income tax of 39.6% is quite low compared to the historical average of roughly 58% and well below the peak rate of 94% seen in 1944-1945 during World War II, as displayed in the charts below. Capital gains taxes were the same as the marginal income tax rate of 73% in the 1920s but were cut sharply and have averaged about 25% over the past century, which is very close to the current rate. Nonetheless, there is historical precedent for both income and capital gains taxes to be increased to address the deficit.

But spending cuts and tax increases typically occur only in a crisis situation – and implementing them during a recession would be unwise, as it could only makes things worse. Thus, the notion of “rolling crises” is not one to be dismissed unless there is a significant shift in political behavior. To paraphrase the cynical statement that is often attributed to Winston Churchill: You can always count on Americans to do the right thing, after they’ve tried everything else. As such, we believe a rise in both income taxes and capital gains seems almost inevitable over the next two decades.

The three wealth killers discussed above are not inevitable. We could get lucky and avoid a market correction, a rise in inflation, and/or an increase in taxes. That luck could come in the form of a sharp increase in growth and productivity thanks to AI – growth can cover a number of sins and faults. But, to quote Seneca, “Luck is what happens when preparation meets opportunity.” There is enough advance warning; and with the right planning, we believe the wealth killers we’ve covered can potentially be avoided – or at least mitigated. Ultimately, we can create our own luck. The future of retirement depends on it.