February 2026: The BakerAvenue Prudence Indicator

BakerAvenue Prudence Indicator Says... 

Long Term: Positive  |   Short Term: Neutral

Rotating, Broadening, and Extending

"The greatest danger in times of turbulence is not the turbulence. It is to act with yesterday's logic."
- Dr. Peter Ferdinand Drucker

The first part of the year has started with the rotational impulse accelerating. The percentage of stocks contributing to (positive) performance has increased, helping to broaden the opportunity set and prolong the market’s advance. Last year’s top-performing stocks have struggled to sustain their momentum, while many of the neglected corners of the market (e.g., small caps, value, etc.) have perked up. We see the developments as more of a rotation (or rebalancing) away from the U.S. technology story rather than a broader risk aversion story. A rotational, non-distributive market is natural and historically helps to improve the health of market advances.

Broader participation across asset classes and within sectors is increasingly creating opportunities for active investors to exploit market inefficiencies and capitalize on mispricings. We remain optimistic while understanding it is a time for precision within asset selections. Investors should balance exposure to enduring leaders with cyclical and international markets that stand to benefit from this new dynamic. Opportunities where growth and pricing power remain strong are no longer confined to U.S. technology. They now encompass a wider range of sectors and regions, reflecting a more globally distributed opportunity set.

Markets were slightly higher in January and remain near all-time highs. Continued earnings strength and resilient economic data served as catalysts, while macro volatility has kept more than a few skeptics entrenched. We are starting a new year with plenty of momentum and no shortage of debate. More than a few investors have overlooked the tailwinds of sustainable growth, enduring industry themes, and repositioning that have propelled markets toward all-time highs. While investors face a complex mix of inputs with solid growth tested by lingering uncertainty and elevated valuations, broader participation is increasing their optionality.

Our baseline forecast is that the economy operates at a moderate pace, fiscal policy turns more expansionary, and interest rates normalize. That backdrop should be supportive of continued corporate profit growth. As this year’s headlines already confirm, the geopolitical volatility will remain elevated. The associated volatility raises the odds of a consolidation, but we would expect investors to use potential dips as buying opportunities as the tailwinds remain underappreciated.

In times like these, it is important to have an investment process in place that removes emotion from the equation. At BakerAvenue, we maintain analytical independence from pre-written market narratives. We remove preconceived biases and defer to our analytical output. Ultimately, our views are only as optimistic or pessimistic as our technical, macro, and fundamental analyses indicate. Currently, our short-term metrics are in a neutral position while our longer-term view is positive.

For those who have been following our market updates (view previous market update videos and commentaries), you will be familiar with several of our key concerns and opportunities. We have continually stated our expectations of moderate growth. There are plenty of adjustments to consider, but our overarching views remain the same. Ultimately, economic and earnings growth will support a grind higher in equities. We believe it is a good time to be active and want to be thoughtful regarding portfolio construction and risk control. 

The Technical Perspective

From a long-term perspective, price trends remain positive as we start a new year. Support lines remain upward sloping and leadership has been supportive with pro-growth sectors outpacing defensive groups in the march toward new highs. Equally weighted and small cap indices have started to pick up relative strength and have helped to broaden the (still) concentrated market. We continue to see an opportunity for tactical repositioning as leadership shifts; we are intently focused here as we consider portfolio tilts.

We are looking for a sustained momentum thrust (e.g., expanding advance/decline lines, an expansion in new highs vs. lows, etc.) to help substantiate the recent move. Internals are in pretty good shape with ~65% of the S&P 500 trading above their respective 200-day moving average. A strong technical foundation raises the odds that any corrective weakness, should it develop, is more likely to be contained. As active managers, we are encouraged by the higher performance dispersion within sectors and industries, as it supports more tactical oversight. We expect the lower correlation backdrop will continue this year, an environment we welcome.

Encouragingly, investor sentiment is still supportive (e.g., bull-bear surveys reflect a neutral bias). Bull markets tend to die on euphoria, not skepticism, so we continue to like this input. We have been noting that positioning (e.g., investors have poured well over $7.7 trillion into money market funds) should act as a buffer to sizeable pullbacks. While not the overriding factor, investor positioning often influences the order of magnitude in market moves (higher or lower). While there is certainly a high bar for allocations given elevated risk-free rates, our view is that investors have room to increase equity exposure.

The Macro Perspective

The uncertainty surrounding shifting policies (e.g., trade, tax, monetary, etc.) raises volatility, but a global fiscal spending cycle and decent economic growth are serving as offsets. Current GDP growth estimates for ’26 are hovering around 2%; we see upside to those forecasts. We believe peak tariff uncertainty is behind us, which should create more visibility for corporate investment decision-making. The benefits from the OBBB will accrue in ’26 and serve as a tailwind for growth.

Interest rates will continue to carry outsized significance. We believe ultra-low interest rates are a thing of the past, and investors should embrace more normalized levels. We expect lower, but not low, interest rates going forward, with a milder cutting cycle in which the Fed recalibrates the policy rate. With decent growth, the Fed doesn’t need to be aggressive with the size and number of rate cuts. The Fed is trying to find a neutral rate, which in their eyes is neither accommodative nor restrictive, and we suspect they find it over the next few meetings. We see a couple more rate cuts this year before a pause. Normalized rate policy is a key factor in our preference for active investment management.

The start of the year has already proven that geopolitical events will represent increasingly material considerations for investors. Policy announcements are moving at a fast pace; to start the year, we have had major energy, housing/mortgage, defense, etc. announcements with potentially material sectoral implications. Encouragingly, most are stimulative. While particularly difficult to position for, we have several market- and non-market-based factors to lean on that help assess materiality and support positioning. We are aware of the uncertainty associated with the administration’s approach, but see counterbalances (e.g., tariff uncertainty vs. deregulatory tailwinds and lower taxes) ultimately offsetting much of the impact.

The Fundamental Perspective

Fundamentally, we continue to focus on the trend in corporate profits and credit metrics. Headwinds, such as higher financing and input cost pressure, have been more than offset by acceptable demand trends. Estimates for revenues and profits have been revised higher over the past few quarters and were a stalwart defense against any bearish forecast. Earnings season has been robust, with the fifth straight quarter of double-digit year-over-year growth expected.

Valuations are now above their long-term averages. However, valuation dispersion within sectors and industries remains elevated with a historically sizable gap between the highest- and lowest-priced assets. We see opportunities in both groups (continued leadership in one, reversion to the mean in the other). Several of the secular growers are commanding high multiples, but also market-leading profitability. Value-oriented pockets offer opportunity, but investors will need to be selective. This is a key factor in our preference for staying active. We continue to advocate for themes like power demand, accelerating capital market activity, and AI-related enthusiasm.

The credit backdrop will be important to monitor as a check on fundamentals and a proxy for risk tolerance. Credit spreads continue to confirm the strength in stocks as they start the new year near 6-month lows. Both investment-grade and high-yield spreads vs. Treasuries remain well below recessionary levels, and support our strong fundamental, and moderate economic growth, views. Corporate cash flows remain healthy, and balance sheets are in good shape. 

Concluding Thoughts

The market’s resilience amid the complex web of considerations has been impressive. The broadening performance profile is an encouraging sign for sustainability of the advance. With several indices trading near all-time highs, the market is becoming more discerning. As we move deeper into the year, a dynamic macro environment, wide valuation spreads, and low correlations are creating a robust opportunity set for active managers.

Our investment philosophy is based on a dual mandate of growing and protecting client assets. We continue to focus on “how” one is positioned, not “if” they should have exposure at all. We are staying active, using volatility to harvest losses while opportunistically deploying capital where appropriate. At this point, our cash weightings remain residual in nature, and we are focusing on strategy positioning vs. our respective benchmarks to control risk. Of course, should the backdrop continue to destabilize, we will take a more defensive stance.

Should you have any questions or comments, please contact BakerAvenue. We are happy to share our thoughts in greater detail, and we welcome the opportunity to speak with you.