The U.S. economy continues to defy conventional expectations, posting robust growth even as key labor market indicators suggest a slowdown. While the delayed January jobs report showed a better-than-expected gain of 130,000 new jobs with unemployment edging lower to 4.3%, the underlying picture reveals significant weakness. The BLS released final benchmark revisions showing initial job counts were revised lower by 898,000 for the April 2024 to March 2025 period on a seasonally adjusted basis. However, the economy maintained impressive momentum with 4.4% GDP growth in Q3 and projected 4.2% growth in Q4, driven by modest retail activity and a surprising 5.3% surge in durable goods orders in November. This disconnect between weakening employment trends and sustained economic expansion highlights the complex dynamics at play in early 2026, as inflation moderates to more comfortable levels (headline CPI at 2.7%, core at 2.6%) while consumer sentiment ticks higher for the second consecutive month.
Globally, the picture is equally mixed: Europe exceeded growth expectations with 1.5% expansion in 2025, Japan upgraded its fiscal year forecast to 0.9% despite ongoing inflation concerns, and emerging markets delivered spectacular returns with Taiwan posting 12.7% growth from AI chip demand even as China’s manufacturing PMI remained mired in contraction. Meanwhile, Bitcoin’s dramatic selloff from $120,000 to $60,000 signals growing investor skepticism about digital assets’ volatility and unclear use case, while strong Q4 corporate earnings—with S&P 500 EPS growth reaching 13% versus the 8% estimate—are being overshadowed by concerns over massive capex spending plans from tech giants and a sharp 23% year-to-date decline in software stocks amid AI disruption fears.
The question facing investors and policymakers alike is whether this contradiction represents a soft landing in progress or signals underlying vulnerabilities that have yet to fully surface.
Labor markets & inflation have cooled but consumers and businesses keep spending!
- The delayed January jobs report showed a better than expected gain of 130,000 new jobs versus the 55,000 estimate. The unemployment rate edged lower to 4.3% while the broader U6 unemployment rate fell to 8.0%. Wages grew 0.4% month-over-month (M/M) or 3.7% year-over-year (Y/Y). Healthcare and social assistance accounted for nearly all of January’s job gains. The BLS also released final benchmark revisions for the period of April 2024 to March 2025. Those numbers saw the initial counts revised lower by 898,000 on a seasonally adjusted basis.
- December’s CPI report came in better than anticipated with headline inflation running at 2.7% and core inflation easing to 2.6%. Food prices jumped 0.7% M/M, energy prices rose 0.3%, and recreation surged 1.2%. Rent increased 0.4% but used cars fell 1.1%. Markets continue to project 2-3 rate cuts in 2026 as recent inflation data have been stable. The PCE price index increased 0.2% in November, matching October’s gain. In the 12 months through November, the PCE Price Index climbed 2.8% after rising 2.7% in October. Core PCE increased 2.8% Y/Y in November.
- U.S. retail sales were flat in December after surging 0.6% in November. On an annual basis, sales rose 2.4%, a considerable step down from the 3.3% pace in November. Sales ex-autos were up 3.3% annually in December. Sales at furniture, clothing, and electronics stores declined while online outlets, building materials and garden centers saw gains. Durable goods orders surged 5.3% M/M in November, up from a revised 2.1% decline in October. The gain was driven by a sharp rebound in transportation equipment orders, which surged 14.7% on a spike in civilian aircraft bookings after a 6.3% fall in October. Core goods rose 0.7%, a strong print for the looming Q4 GDP report. The U.S. economy grew 4.4% in Q3 and the Atlanta Fed expects 4.2% growth in Q4.
Source: U.S. Bureau of Labor Statistics
Manufacturing rebounds in January along with consumer sentiment
- Surprisingly, the manufacturing sector surged back into expansion territory in January based on the latest ISM Manufacturing PMI reading. The headline number of 52.6 was up from 47.9 in December, boosted by strong rebounds in production, new orders, and employment. Although the headline readings were positive, survey respondents highlighted caution and overall business softness. The ISM Services PMI was unchanged in January at 53.8. Business activity strengthened while new orders softened. The University of Michigan consumer sentiment reading for February ticked higher for the second straight month. Most of the increase was due to the easing of inflation fears. While consumers continued to stress over high prices, they expected inflation to moderate in the next year.
European GDP tops estimates, Japan upgrades growth forecast from a low starting point
- The eurozone economy expanded 0.3% quarter-over-quarter (Q/Q) in Q4, slightly ahead of expectations. Spain surpassed expectations with robust household consumption and fixed investment. The Netherlands expanded by 0.5%, driven primarily by exports. Germany and Italy both grew 0.3% while France’s GDP expanded 0.2%. For the full calendar year 2025, the Eurozone economy expanded by 1.5%, up from 0.9% in 2024. In 2026, GDP growth is forecast to moderate a bit amid geopolitical tensions and trade policy uncertainty.
- The Bank of Japan upgraded its economic growth forecast for the fiscal year ending in March 2026 to 0.9% from 0.7% in October 2025 and raised its GDP expansion outlook for the 2026 fiscal year to 1.0% from 0.7%. The BOJ also sees difficult conditions moving forward with rising prices and wages. Inflation has run above the BOJ’s target for 45 consecutive months, which could lead to additional monetary tightening.
China PMIs miss but strong growth coming from other key EM countries!
- China’s official manufacturing PMI came in well below forecasts at 49.3 in January, down from December 50.1. The manufacturing PMI has been in contractionary territory for nine of the past ten months and suggests that December’s data may have been a blip rather than the start of a recovery trend. There was a broad-based slowdown across most categories. China’s large companies continued to outperform the medium and small ones, with large enterprise PMIs still in expansion while medium and small enterprises were in contraction. China’s official non-manufacturing PMI fell to a 37-month low in January at 49.4 (down from 50.2 in December). One of China’s main goals is to improve services consumption and quality to boost domestic demand as a growth engine.
- Taiwan’s economy grew 12.7% Y/Y in Q4, fueled by strong demand for technology and semiconductor chips that power AI. GDP increased 8.6% in 2025, the fastest pace in 15 years. South Korea’s GDP contracted 0.3% Q/Q in Q4, the steepest slowdown since Q4 2022. For the full year, South Korea’s economy grew 1.0%, its slowest annual expansion since 2020. In Q4, a slump in construction investment and a pullback in exports outweighed modest gains in consumption. Mexico’s economy showed a 0.8% Q/Q expansion in Q4 2025, rebounding from a 0.3% contraction in Q3 and leading to 1.6% growth for 2025.
Strong Q4 earnings season being overshadowed by massive capex spending & software selloff
- Two-thirds of the way through the Q4 earnings season, results have far exceeded expectations again. S&P 500 EPS growth has been 13% in Q4 versus the estimate of 8% growth. Two key themes have emerged during this reporting season. The first is the increased capex spending by the large hyper-scalers for 2026. Amazon, Alphabet, Meta, and Microsoft each increased their previous guidance for capex spending with the collective spending now expected to top $600B, nearly double 2025 levels. Three of the four players sold off on the news of higher spending as investors questioned the profitability from higher capex spending.
Sources: Bloomberg, III Capital Management
- The second major theme impacting markets is AI impact on software companies. Earnings have been strong for software companies in the S&P 500 in Q4, but the sector has fallen 23% YTD as of this writing. According to Goldman Sachs, the dramatic fall in software valuations brings their P/E ratio down to 21, consistent with companies that grow revenue in the 5-10% range, versus consensus two-year forward growth estimates of roughly 14% for the sector in the coming year. Profit margins for the software sector have grown to over 26% but AI disruption may dramatically impact the winners and losers in the sector. Software is 8.1% of the S&P 500 but represents a much larger percentage of credit markets, especially BDCs and leveraged loans.
Time to be wary of digital assets like Bitcoin?
- We have been reluctant to formalize a broad recommendation for digital assets like Bitcoin, largely because the use case remains unclear and correlations are high to other risk assets. After touching $120,000, Bitcoin has sold off over the past month, briefly touching $60,000 before rebounding. Correlations have broken down further, with most digital assets trading like unprofitable technology companies as opposed to digital gold. Access has become easier through the proliferation of ETFs, but the asset has maintained its high levels of volatility. We note, however, that prior price declines of this magnitude are common and have turned out to be buying opportunities over the long-term.
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