The U.S. economy continued to demonstrate resilience during the fourth quarter of 2025, delivering more than 2% GDP growth. Equity markets climbed higher during the quarter despite notable headwinds which included elevated valuations, moderating labor markets and persistent policy uncertainties. We ended the year with the largest 10% of U.S. stocks accounting for 78% of the total market capitalization. This compares with the previous peak of 73% in 2000 during the internet years.
The bond market posted positive returns in Q4 as the Federal Reserve delivered the final rate cuts of the year. The Federal Reserve reduced rates an additional 50 basis points in the quarter (25 basis points each in October and December), bringing the federal funds rate to a range of 3.50%-3.75% by year-end. These actions steepened the yield curve and nearly ended the inversion that had persisted since 2022.
A look back on 2025 reveals a volatile year with remarkable equity market resilience. The upheaval triggered by President Trump’s sweeping tariff announcement on April 2, dubbed “Liberation Day”, sent shockwaves through global markets. The S&P 500 plunged nearly 19% from its February peak to an April 8 low, officially entering correction territory and hovering precariously close to bear market status. By early May, the market had completely erased the Liberation Day losses. The announcements of a 90-day pause on certain tariffs and the commencement of trade negotiations led to a sharp rebound, with the S&P 500 posting a 38% gain from the April 8 low through year-end. The S&P 500 went on to establish 39 new all-time highs during 2025, making it one of the top years on record for reaching new peaks. However, through all the positivity, the primary winners for the year were the favored few now referred to as the Mag-7 which contributed the lion’s share of index performance in 2025. For the year, Growth styles outperformed Value, and Mega-Cap outpaced small- and mid-cap indices.
Looking at underlying fundamentals, which is where we focus our efforts, corporate earnings remain robust. This backdrop is supporting equity valuations although concentration concerns and disparate valuations by size leave us concerned about index levels. Peering into the new year we expect consumer spending to hold up reasonably well despite sentiment remaining near record lows. A shift in the major stock market indices is underway from services to goods as the pricing power for goods is definitely firming. Household balance sheets remain strong in aggregate, with some economists forecasting that the OBBBA (“The One Big Beautiful Bill Act”) will result in personal income increasing by $65B in 2026.
We recognize that forward valuations are elevated, and while they have historically been terrible market timing devices, they do represent investor sentiment, which remains bullish. The market’s upside is more sensitive to disappointments in earnings or macro trends. We think one should accept that high valuations compress future returns, with more moderate gains or sideways markets considered plausible rather than assuming double-digit performance.
We approach 2026 with eyes wide open to both opportunities and risks. Strong corporate balance sheets, robust earnings and supportive (if less accommodative) monetary policy provide foundations for further gains. However, elevated valuations, potentially overly optimistic earnings expectations, policy uncertainties, and stretched investor sentiment create vulnerabilities should conditions deteriorate.
As always, we would enjoy discussing how all of this affects our portfolio. We look forward to speaking with you in the new year and are always available for any thoughts you have.