Osterweis Capital Management Q1 2026 Equity Outlook: Strong Market Performance Amid Rising Corporate Bankruptcy Concerns

The Q1 2026 Equity Outlook from Osterweis Capital Management presents a compelling portrait of the current U.S. economic and market environment, revealing what might be described as a “prosperity paradox”—strong aggregate economic and market performance occurring simultaneously with elevated corporate distress. This juxtaposition requires careful interpretation by market participants seeking to navigate the evolving landscape.

The U.S. economy demonstrated remarkable resilience through 2025, with real GDP accelerating to a 4.3% annual growth rate in the third quarter [1]. This growth rate significantly exceeds long-term trend expectations and represents a substantial acceleration from earlier periods. The labor market reinforced this positive narrative, with unemployment remaining relatively tame at 4.4% as of December 2025 [1]. These foundational economic indicators suggest an economy operating with substantial momentum and broadly shared prosperity.

The equity market validated these economic fundamentals through robust performance. The S&P 500 Index delivered a total return of 17.9% for 2025 [1], providing meaningful wealth creation for investors and validating strong corporate earnings. This return occurred despite elevated interest rate expectations and ongoing geopolitical uncertainties, suggesting genuine fundamental support rather than purely speculative momentum.

However, the most striking element of the Osterweis analysis is the record-setting level of corporate bankruptcies that accompanied this economic strength. According to S&P Global data, 2025 recorded 785 corporate bankruptcies—the highest total since 2010 and only exceeded by the post-Great Financial Crisis peak [2]. This represented the third consecutive annual increase in bankruptcy filings, indicating a persistent rather than transient trend.

The Washington Post reported that these bankruptcies were led primarily by industrials and consumer discretionary businesses [3], sectors that historically serve as bellwethers for broader economic health. This sectoral concentration suggests that while the aggregate economy performed well, specific segments—particularly those with higher leverage profiles—faced pronounced stress. Monitor Daily analysis attributes this trend to “credit market stress and refinancing challenges facing leveraged companies” [2], highlighting the differential impact of elevated interest rates across the corporate landscape.

As of January 22, 2026, market indices reflect continued resilience amid these mixed signals [0]. The S&P 500 traded near all-time highs at approximately $6,913, gaining 1.48% in the recent period. The NASDAQ continued its upward trajectory at approximately $23,436 with a 1.14% gain, while the Dow Jones outperformed with a 3.79% advance. Perhaps most notably, the Russell 2000 surged 9.53%, suggesting meaningful rotation into smaller-cap, domestically-focused companies.

This small-cap strength may reflect several dynamics: potential policy expectations favoring domestic industrials, relative valuation attractiveness versus large-cap technology names, and speculation that interest rate pressures may ease. However, small-cap companies typically carry higher debt loads and face refinancing challenges first in elevated rate environments, making this strength potentially vulnerable if credit conditions remain restrictive.

The 2025 market environment fundamentally demonstrates that aggregate statistics can mask significant underlying dispersion. While headline GDP growth of 4.3% and 17.9% equity returns suggest universal prosperity, the bankruptcy data reveals a more complex reality. Companies with strong balance sheets and stable cash flows have thrived, while leveraged entities—particularly in industrials and consumer discretionary—have faced existential pressure.

This bifurcation creates both challenges and opportunities for active managers. The Osterweis analysis suggests using a price/earnings-to-growth (PEG) approach to assess valuations, finding a current market PEG of approximately 1.5x [4]. This compares favorably to the historical average PEG of 2.4x, indicating that equities may remain reasonably valued relative to earnings growth expectations when proper growth adjustment is applied.

The sector performance data reveals increasingly pronounced market segmentation [0]. Basic Materials (+1.15%) and Consumer Cyclical (+0.60%) sectors led gains, while Utilities (-2.70%) suffered the steepest losses. The nearly 400 basis point spread between the best and worst-performing sectors on any given day indicates not random noise but structural rotation.

Industrials’ position among the day’s underperformers despite the overall market advance aligns with the bankruptcy data showing this sector among the most stressed [3]. This convergence between real economy distress signals and market performance validates the importance of sector-specific analysis in the current environment.

The bankruptcy trend potentially serves as a leading indicator for broader credit market conditions. With leveraged companies facing refinancing challenges in an elevated rate environment, stress has concentrated among the most vulnerable issuers. The question for 2026 centers on whether this stress remains contained to already-distressed entities or begins spreading to higher-quality credits.

Bloomberg projections of S&P 500 earnings per share growth of 17% in 2025 and 13% in 2026 provide fundamental support for current valuations [4]. However, these projections assume continued corporate profitability that may be challenged if credit stress materially impacts operating performance across a broader company set.

The analysis reveals several risk dimensions that merit monitoring. Credit contagion risk stands as the primary concern—with bankruptcy rates at 15-year highs, stress could potentially spread from distressed entities to related companies and sectors through supply chain, lending, and customer relationships [2][3]. The concentration of bankruptcies in industrials and consumer discretionary suggests these sectors warrant enhanced vigilance.

Small-cap vulnerability represents a secondary concern. The Russell 2000’s strong performance may be testing stretched valuations, and small-cap companies historically face refinancing challenges first in elevated rate environments. Should credit conditions remain restrictive, small-cap indices could experience pronounced corrections.

Market segmentation risk also warrants attention. The growing divergence between outperforming and underperforming sectors indicates increasing complexity in portfolio construction. The nearly 4 percentage point gap between Basic Materials’ +1.15% gain and Utilities’ -2.70% loss on a single trading day [0] suggests that sector selection has become paramount.

Despite these risks, the environment presents notable opportunities. The PEG analysis suggesting reasonable valuations relative to earnings growth provides a foundation for constructive positioning in quality assets [4]. Companies with strong balance sheets and stable cash flows continue to perform well, and selective exposure to these entities may offer attractive risk-adjusted returns.

The GDP resilience of 4.3% and labor market stability at 4.4% unemployment [1] suggest the economy possesses substantial momentum entering 2026. This fundamental strength provides a floor for market valuations and supports corporate earnings expectations. The strong Q3 growth rate indicates the economy is not merely surviving but expanding at a meaningful pace.

The rotation into small-caps, if sustained, could benefit domestically-focused investment strategies. Should policy developments favor domestic industrial activity or should interest rate expectations ease, small-cap indices could continue their outperformance.

Market participants should prioritize tracking high-yield bond spreads as an indicator of credit market stress, Q1 2026 earnings reports for evidence of broadening corporate distress, Federal Reserve communications regarding rate trajectory and its impact on refinancing conditions, and the trajectory of bankruptcy filings to assess whether the trend continues, stabilizes, or peaks.

The Osterweis Capital Management Q1 2026 Equity Outlook documents a U.S. economy and equity market characterized by strong aggregate performance alongside meaningful sector-specific stress. Key quantitative highlights include a 17.9% S&P 500 total return for 2025, 4.3% real GDP growth in Q3 2025, 4.4% unemployment as of December 2025, and 785 corporate bankruptcies representing the highest count since 2010 [1][2].

The market environment increasingly favors quality-focused equity selection over broad market exposure. High-quality companies with strong balance sheets continue to perform well, while leveraged companies across industrials and consumer discretionary face ongoing pressure. This dynamic creates a bifurcated market where security selection and credit analysis become critical success factors.

The sector dispersion evident in recent trading data—with Basic Materials gaining 1.15% while Utilities declined 2.70% [0]—reflects the underlying economic bifurcation. This environment requires nuanced portfolio construction that acknowledges both the aggregate economic strength and the concentrated sector stress.

Forward-looking considerations include the trajectory of corporate bankruptcies, Federal Reserve policy direction, high-yield credit market conditions, and the durability of small-cap momentum. The convergence of strong economic fundamentals with elevated credit stress creates an environment demanding careful risk management alongside opportunistic positioning in quality assets.