Image Source: Pixabay

The past few weeks have been a reminder that markets can change direction faster than investors can make sense of them.

Early November was filled with warnings about an AI bubble, stretched valuations and the risk of big drawdown.

But before the month was gone, a quick reversal got everybody talking about a new stock market rally.

This move has sparked a new wave of bullish forecasts for 2026, including calls for the S&P 500 to reach 7,500 to 8,000.

So, in the span of less than a month, what exactly changed? And should investors trust this new wave of optimism?

What flipped the switch for markets

The key change was not economic data, but the Fed’s tone. Until mid-November, markets expected the rate cut in early 2026.

A delayed September jobs report briefly pushed expectations further out, which helped trigger the early-month wobble in tech stocks.

Then several senior Fed officials, including New York Fed President John Williams, indicated that the central bank was paying closer attention to signs of labour-market cooling.

Within days, the entire forward curve for interest rates has changed. The market is now pricing an 80% chance that the Fed will cut rates at its 9-10 December meeting.

A week earlier, the odds were below 30%.

JPMorgan moved quickly, reversing its own forecast and now expecting cuts in both December and January.

Again, the data was not the major driver behind the move. Durable goods orders for September arrived roughly in line with forecasts.

Initial jobless claims fell to their lowest level since April.

Continuing claims rose to 1.96 million, pointing to a slow, but not yet collapsing, labour market.

Nevertheless, markets responded less to numbers and more to the view that the Fed no longer sees inflation as the danger it once did.

Once that became clear, the mood changed, and the stock market rally returned almost instantly.

Why forecasts for 2026 jumped toward 8,000

As rate expectations fell, banks released their market outlooks for 2026. Deutsche Bank issued the boldest call, placing the S&P 500 at 8,000 by the end of next year.

The forecast leans on earnings momentum, stronger inflows and ongoing buybacks.

S&P 500 companies posted 13.4% earnings growth in the third quarter. That is an unusually strong pace for this stage of the cycle.

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Source: Factset

HSBC is targeting 7,500. Morgan Stanley expects around 7,800 and describes the current period as the early stage of a new bull run.

Wells Fargo is in a similar range and sees a split year, with a reflation-driven first half and a stronger AI-powered move in the second half.

JPMorgan’s base case is 7,500 with room for the index to move above 8,000 if the Fed cuts more aggressively through 2026.

Source: Bloomberg

The common thread in these calls is the discount rate. When markets believe that borrowing costs will fall through 2026, the pressure on valuations eases.

Banks are not ignoring AI risks or high multiples. They are recalibrating expectations in a lower-rate world.

AI spending is still rising across cloud, servers and data-center infrastructure.

Companies with real exposure to this trend have raised guidance. Those fundamentals become far more valuable when the cost of capital drops.

The economic and political twist that investors should not ignore

Although the stock market rally has been driven by rate expectations, the broader picture is more mixed.

The labour market is still showing cracks beneath the surface. Hiring is slow, and some large employers have announced layoffs.

Continuing claims drifting higher suggest that once workers lose a job, finding a new one is taking longer.

The consumer picture is split. Households in the top income brackets are still spending and remain tied closely to equity-market performance. Lower-income consumers face tighter credit and rising delinquencies.

This imbalance forms a “K-shaped economy” that reacts quickly to shifts in asset prices.

Wells Fargo has warned that a sharp market drop could become an economic problem because consumption at the top end drives so much of today’s demand.

Politics adds another layer. Kevin Hassett, a long-time ally of President Donald Trump and current head of the National Economic Council, is seen as a frontrunner to replace Jerome Powell when his term ends. He has openly supported lower rates in the past.

Markets take that as a bullish sign for equities in the near term. However, it raises questions about the Fed’s long-term independence and inflation credibility.

These factors have not been priced into the most optimistic forecasts.

Is the new optimism built to last?

The rally shows how sensitive markets are to expectations. Investors want to believe that the rate-cutting cycle is starting soon.

They want confirmation that earnings can grow in the low-double-digit range next year.

They want a political environment that does not threaten credit markets. In this situation, AI becomes the bridge that links policy hopes with earnings growth.

There is logic behind the optimism. If the Fed cuts in December and January, if earnings continue to grow at around thirteen to fifteen percent annually and if there is no major shock from policy or geopolitics, the S&P 500 can reach the levels banks are now promoting.

But these are layered assumptions, not certainties. Markets have a habit of pricing best-case scenarios long before those scenarios materialise.

That is why the shift in tone from the Fed had such power.

A major takeaway from the past month is that liquidity still drives technology valuations more than any single theme.

AI infrastructure and cloud capacity are expanding. Companies have already raised full-year guidance thanks to AI server demand.

But the valuations of leading AI names already assume a long stretch of strong growth.

Any slowdown in capex, any regulatory action or any stumble in margins would trigger steep single-stock reactions.

The more delicate risk sits outside technology. A politicised Fed could cut rates faster but also trigger volatility if markets see inconsistent or unpredictable policy signals.

The credit picture for lower-income households requires watching. Equity markets tend to follow these early signs with a lag.

The K-shaped structure of the economy means that a market shock would hit spending at the top end and feed quickly into corporate results.

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