Investment Strategy

Still a two-track consumer in 2026

Solid 2025 holiday sales provided a fitting end to a strong year for consumer spending. Sales growth of over 4% from a year ago (as estimated by the National Retail Federation¹) was paced by upper-income households flush with cash.

The most noteworthy feature of household spending last year was the widening gap between upper- and lower-income spending embodied in a so-called “K-shaped” pattern of economic growth. The top 10% of income earners were responsible for almost 50% of consumer spending in 2025 compared to roughly 35% in the early 1990s, according to Moody’s Analytics. Upper-income consumers drew strength from relatively strong growth of real (inflation-adjusted) earnings compared to lower-wage workers and from sizable windfall gains in household wealth acting as “dry powder” for big-ticket spending.

Anticipating another windfall in 2026

We expect another good year for consumer spending in 2026. Key factors supporting household demand include subdued inflation — preventing the usual late-cycle rise in interest rates and pressure on real incomes common in a maturing economic growth cycle — and unusually large, late-cycle tax cuts of over $190 billion as an added tailwind to help propel spending.² In our view, strengths should outweigh headwinds from slowing job growth, lingering tariff passthrough, high-cost essentials, and low sentiment levels.

We also expect another year of solid economic and earnings growth to sustain the rally in financial assets that, in turn, is powering gains in household wealth perpetuating the “K-shaped” pattern of consumer spending skewed toward upper-income families.

Federal Reserve (Fed) data show that 72% of household net worth in the third quarter of last year was held by the top 20% of households by income — much of that in rapidly appreciating stocks and other financial assets.³ Concentration of assets within that group explains the more than 30% gain in their household wealth between the start of the Coronavirus pandemic in 2020 and last year’s third quarter, compared to a more moderate 18% among the other 80% of U.S. families over the same period. Their 28% share of household net worth is skewed more toward modestly rising home values. (See Chart 1).

Chart 1. A widening gap between upper- and lower-income household wealthSources: Wells Fargo Investment Institute and Federal Reserve Board. Quarterly data, December 2016 – September 2025. Indexed to 100 as of March 2020. Q3 = third quarter.

The relatively small share of household wealth owned by lower and middle-income families does more than reduce the dry powder available for spending. It also is less effective in cushioning the group from financial stress tied to borrowing needed to finance the high cost of essentials spending. According to Fed data, rapid increases in wealth have helped reduce household leverage (measured by the ratio of debt to net worth) to a 1963 low.⁴ However, deleveraging — and the lower ratio of debt payments to income suppressed by it — has been largely confined to upper-income families. Financial stress among lower-income families has forced the group to take on debt, including the growing use of buy now, pay later (BNPL) loans by consumers that risk encouraging overspending and borrowing. Lower-income financial stress helps explain why a still-elevated credit-card delinquency rate has retreated little from its early-2025 peak.

What it may mean for investors

In our view, the U.S. economy is well-positioned for another year of strong, consumer-led growth in 2026, with broadening investment spending providing an added boost. However, we expect the “K-shaped” consumer backdrop to persist as household finances and spending continue to move along two different tracks. Lower-income households with little (or no) exposure to financial wealth likely will remain pressured by the high cost of essentials and modest further wage disinflation, both contributing to rising debt.

We think key trends should help alleviate some of the burden, at least temporarily, including lower short-term borrowing costs, extended rental disinflation, subdued oil prices, and a diluted tariff impact from drawn-out implementation. Larger tax refunds may be an added tailwind, though we note that this stimulus is more likely to benefit middle- and upper-income groups. Meanwhile, we anticipate another year of double-digit equity-market returns,⁵ which should feed into further gains in financial wealth encouraging another burst of spending by upper-income groups.

¹ National Retail Federation, “CNBC/NRF Retail Monitor’s December Data Shows Strong Holiday Season Spending,” January 12, 2026.

² Piper Sandler, “Tax Windfall=Spending Surge,” January 14, 2026.

³ Federal Reserve Board, “The Financial Accounts of the U.S.,” January 9, 2026.

⁴ Federal Reserve Board, “Financial Accounts of the U.S.,” January 9, 2026.

⁵ Equity market as represented by the S&P 500 Index.

Fourth-quarter earnings likely grew at a solid pace

U.S. equities entered the new year with positive momentum, extending gains from late 2025. Against this backdrop, fourth-quarter earnings season is underway, and results will be critical in determining whether recent market strength can be sustained. In our view, fourth-quarter earnings likely grew at a solid pace.

We expect seven of the 11 S&P 500 Index sectors to post positive earnings growth, led by Information Technology, Financials, and Communication Services. In our view, the Energy sector will likely be one of the biggest laggards as oil prices declined throughout the fourth quarter. We believe the Consumer Discretionary sector is also likely to underperform the composite index, as the sector faces higher costs, contracting margins, and a cautious consumer. Markets will be watching capital spending and consumer trends for the remainder of the year as earnings season unfolds.

The banks started off on a high note with most companies beating expectations and reaffirming guidance. Technology companies start to report this week, and investors will look for guidance regarding the profitability of artificial intelligence (AI), capital expenditures, and AI demand. Given high valuations in the Information Technology sector, these reports should be key market drivers.

We expect earnings to broaden with cyclical sectors leading over defensive and consumer-oriented ones, and so does the consensus as seen in the chart below. This outlook is reflected in our guidance where we are most favorable on the Financials sector and hold favorable ratings on Industrials and Utilities. We hold unfavorable ratings on the Consumer Discretionary, Consumer Staples, and Health Care sectors.

Chart 2. Bloomberg consensus expects solid S&P 500 Index earnings growth in the fourth quarterSources: Wells Fargo Investment Institute and Bloomberg. Earnings per share (EPS) growth measures consensus fourth-quarter 2025 EPS expectations as of January 20, 2026 versus fourth-quarter 2024 EPS. “Info. Tech. = Information Technology. Comm. Services = Communication Services. Cons. Stpls. = Consumer Staples. Cons. Disc. = Consumer Discretionary.” Past performance is no guarantee of future results. 

Assessing our 2026 municipal bond outlook

Muni bond markets finished 2025 with strong momentum, but the first three weeks of 2026 have been choppy as munis have dealt with a surge of new issuance and higher 10-year U.S. Treasury yields, after a near six-week period of them being range bound between the 4.10% – 4.20%. Our thesis remains intact as we still believe that positive tax-equivalent yields remain attractive and can provide a potential buffer against interest-rate volatility. Also, the muni bond yield curve remains steep, creating opportunities for positive returns especially in the intermediate portion of the curve. We currently favor the 7-to 19-year maturity range where investors can potentially pick up incremental yield.

Despite price uptrends, there are risks to our outlook, especially around demand eventually not keeping pace with expected supply. However, we still anticipate that lower interest-rate levels on the short end of the curve may push investors away from cash into higher-yielding fixed income. Also, from a valuation standpoint, we have seen the 10-year muni-to-Treasury yield ratio fall to a 12-month low to start the year, which suggests that munis have increasingly become relatively more expensive, and this may keep some investors on the sideline awaiting better entry opportunities later in the year.

In balance, we remain favorable on munis, as they still offer higher tax-adjusted yields relative to corporate securities with similar credit ratings. In many cases, they can offer the additional benefit of being exempt from state and local taxes. Selectivity remains key as some states and sectors display higher credit risks than others. Overall, we expect positive single-digit returns for munis over the next 12 months.

Chart 3. 10-year muni-to-Treasury yield ratio at 12-month lowSources: Wells Fargo Investment Institute and Bloomberg, January 20, 2026. The 10‑year muni‑to‑Treasury yield ratio is a way to compare how much income (yield) investors earn from 10‑year municipal bonds versus 10‑year U.S. Treasury bonds. It tells whether tax‑free municipal bonds are relatively cheap or expensive compared to U.S. Treasuries. Because muni income is usually tax‑free, a muni could still deliver more after‑tax income even if the ratio is low. Past performance is no guarantee of future results.

Industrial metals and the race to secure supply

Industrial metals started the year on a positive note, with a 3.6% return, through January 16. Behind this strength are expectations for improving macroeconomic conditions, and concerns that global mined copper supply could fall short of expectations once again in 2026.

In our view, though, underpinning these strengths has been a renewed interest in commodities both by investors and governments around the globe. As we mentioned in our January 14, 2026 "State of the Markets" report, “The Amazing Race,” we are likely to witness a global race to secure natural resources, and more specifically, the commodities needed to scale up the infrastructure needed for AI and other automation technologies in the years to come.⁶

The development of such emerging technologies requires many commodities, such as copper, that are structurally undersupplied. As seen in Chart 4, global demand is expected to outpace mined supply growth and lead to a deficit of roughly 30% globally by 2035.⁷ Given the average lead time of roughly 17 years for mine development, this creates an imbalance in supply and demand that cannot be fixed overnight. It is not just copper either, projections for commodities such as nickel, cobalt, and rare earth minerals show similar trends of tight supply as demand from electrification and AI outpaces sluggish mine supply growth.

Our expectation for industrial metal demand to trend higher in the coming years stems from companies and governments seeking critical metals to fuel their technological AI race, which will likely be a tailwind for higher prices over the long run. While tactically, we view the reacceleration of economic conditions in 2026 as a near-term tailwind for outperformance relative to the broader Bloomberg Commodity Index. Therefore, we believe investors can benefit from commodity exposure, and more specifically exposure to our two favorably rated sectors, industrial metals and precious metals.

Chart 4. Global copper demand forecast through 2040Sources: Wells Fargo Investment Institute and International Energy Agency. Annual data and forecasts are as of May 31, 2025.

⁶ “State of the Markets: The Amazing Race,” Wells Fargo Investment Institute, January 14, 2026.

⁷ “Global Critical Minerals Outlook 2025,” International Energy Agency, June 2025.

Small/mid buyouts see steady growth

Small/mid buyouts involve acquiring controlling stakes in established, profitable U.S. companies with enterprise values ranging from $25 million to $1 billion (also known as middle-market businesses)⁸. Small/mid buyouts typically seek to enhance value through operational improvements and business expansions.

Through the third quarter of 2025, small/mid buyout activity showed continued growth (see Chart 5). Deal value during the quarter reached its highest level since 2022, reflecting improved confidence among fund managers⁸. By deal count, small/mid buyouts represented nearly 70% of U.S. buyout transactions. However, their share of total deal value declined as megadeals became more prevalent⁸.

Small/mid buyout valuations during the quarter moved closer to pre-COVID-19 levels, suggesting improved alignment between buyers and sellers⁸. Founder-owned businesses remained an important source of transactions within the small/mid buyout space⁸. According to Pitchbook, fund managers often seek to support growth in these companies by expanding product offerings, entering new markets, or investing in employees to build scale⁸.

For 2025, the number of exits—whereby fund managers sell their portfolio companies and return capital to investors—is on track to exceed 2024 levels and remains above pre-pandemic averages⁸. Given their smaller size, small/mid buyouts are generally less dependent on public listings for exits, relying more on sales to strategic buyers or other private-equity firms⁸.

With more than 200,000 middle-market companies in the U.S. as of January 2025⁹, we believe the opportunity set for small/mid buyouts remains broad. We believe their smaller size and lower dependence on debt financing have supported greater resilience during recent periods of elevated interest rates and economic uncertainty.

Looking ahead, we continue to favor Small/Mid Buyout sub-strategies given the breadth of opportunity and resilient dealmaking, as well as their low reliance on debt financing. We believe the sub-strategy can help navigate the uncertain macro environment before a broad-based private-equity recovery takes hold.

Chart 5. Small/mid buyouts showed continued growth in deal and exit activities in 2025Sources: Wells Fargo Investment Institute and Pitchbook. Data as of September 30, 2025. The chart shows the growth in quarterly deal and exit activities for the first 3 quarters of 2025 relative to the same period in 2024. For Pitchbook data disclosures, please see page 9.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

⁸ Pitchbook, “US PE Middle Market Report”, December 12, 2025.

⁹ National Center for the Middle Market, “Year-End 2024 Middle Market Indicator”, January 21, 2025.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, January 26, 2026. Please see Wells Fargo Investment Institute's Asset Allocation Strategy Report for more detailed, investable ideas in each asset group.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Forecasts and targets are based on certain assumptions and on views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. Municipal bonds are subject to credit risk and potentially the Alternative Minimum Tax (AMT). Quality varies widely depending on the specific issuer. Municipal securities are also subject to legislative and regulatory risk which is the risk that a change in the tax code could affect the value of taxable or tax-exempt interest income. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication Services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the Communication Services sector may also be affected by rapid technology changes, pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players, reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. Real estate investments have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

An index is unmanaged and not available for direct investment.

Bloomberg Commodity Index is comprised of 22 exchange-traded futures on physical commodities and represents 20 commodities weighted to account for economic significance and market liquidity.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

Pitchbook Data – Pitchbook uses a variety of publicly available sources found in targeted online searches including more than 1,000,000 web crawlers using national language processing and machine learning, secondary sources (those authored by someone not directly involved in the deal or fund), news (largest source of information) and other online sources. Quality assurance uses preventive validations, corrective validations, and mutual reviews in an effort to ensure accuracy of data. Data is educational and illustrative purposes only and there are no guarantees as to accuracy of data or content.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

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