Investment Overview: 4th Quarter 2025

The economy

As we turn the page to 2026, the U.S. economy continues to surprise with its underlying strength, even as headlines and sentiment surveys paint a more cautious picture. Throughout 2025, consumer confidence remained subdued, yet actual spending told a different story — Americans kept shopping, and holiday retail sales came in stronger than expected, with Visa and Mastercard reporting gains of 4.2% and 3.9%, respectively. This divergence between how consumers feel and how they behave has been one of the most striking features of the past year, and it has registered in the GDP data: After a soft start, real GDP accelerated sharply, posting an estimated 4.3% gain in the third quarter and keeping annual growth near the 2% mark. Nominal GDP surged at an annualized rate of 8% in Q3, indicating healthy corporate profit growth and helping to stave off recessionary fears. 

The labor market, while showing signs of softening, has not deteriorated in a way that typically signals broader economic trouble. The unemployment rate edged up to 4.6% in November and job creation slowed, but weekly jobless claims have held steady. While hiring has cooled, widespread layoffs have not materialized. Wage growth moderated to 3.5% year-over-year, and the prime employment-to-population ratio remains stable, providing a buffer against more severe labor market weakness. Importantly, the usual recessionary pattern — where labor market weakness is confirmed by a drop in business investment — has not emerged. Corporate capex remains supported, especially in technology and AI, and the recently passed OB3 tax bill is expected to further boost both consumer spending and investment as tax refunds begin to flow in February.

Inflation, which dominated headlines earlier in the year, has begun to fade as a concern. Both headline CPI and wage growth have moderated, and market-based measures indicate that inflation expectations are now well anchored. Leading indicators such as slowing rent growth and stable car prices reinforce the view that pricing pressures are easing. The Federal Reserve is approaching a neutral policy stance, and recent rate cuts are expected to provide additional support for growth in 2026. There is room for further easing if inflation remains contained, and other global central banks are also moving toward more neutral stances.

Housing remains a sector to watch. After a choppy year, there are tentative signs of improvement: Pending home sales have picked up, and prices have stabilized in recent months. However, relief is still needed for a full recovery, and the sector’s performance will be critical for broader economic momentum in the coming quarters. Meanwhile, consumer spending has been supported by household savings and wealth, but the sustainability of this support will depend on continued labor market stability and policy tailwinds.

Manufacturing remained a notable weak spot for the U.S. economy in the fourth quarter of 2025. Activity continued to contract, with key indicators such as the ISM Manufacturing PMI staying below the expansion threshold, reflecting subdued demand and ongoing headwinds from elevated input costs and tariffs. While some regional surveys hinted at stabilization, the goods sector overall faced a significant hit, and new orders and employment in manufacturing remained under pressure. 

On the global stage, attention is focused on the potential for aggressive stimulus in China and the evolving policy landscape in Europe and Japan. U.S. “exceptionalism” may be pausing, as other economies seek to right their yield curves and stabilize local currencies. The interplay between global monetary policy, trade dynamics, and geopolitical developments will be key factors shaping the outlook for 2026.

As we look ahead to 2026, the consensus is for GDP growth to remain at or above 2%, with modest improvement anticipated as policy support and productivity gains offset lingering risks from tariffs and global uncertainty. The coming year will test whether the resilience seen in 2025 can be sustained, but for now, the data continues to point to an economy that is holding together — supported by resilient consumers, steady corporate profits, and a labor market that, while softer, is far from collapsing. The outlook remains constructive, though vigilance is warranted as policymakers and investors navigate a complex and evolving landscape.

Fixed income

Fixed income markets continued to perform generally well as yields declined over the fourth quarter on short- to intermediate-term bonds. The Bloomberg U.S. Aggregate Index was up a respectable 1.10% for the quarter and an impressive 7.30% for the year. Long-term yields rose in December as the perceived risk of an economic recession decreased, driving mostly negative returns for long-duration fixed income indices.      

The 10‑year Treasury yield finished the year at 4.17%, modestly lower than mid‑year highs, but slightly up from the previous quarter. The yield curve steepened throughout the quarter, with 2‑year yields falling more than long rates. Of note, interest rate volatility was substantially lower in the fourth quarter compared to recent periods as investors perceived less inflation uncertainty given slowing wage growth and muted tariff impacts. As such, investment-grade and high-yield corporate credit spreads remained intact at historically tight levels reflecting low default rates and a stable earnings outlook.  

The Federal Reserve cut its Fed Funds target rate on two separate occasions during the fourth quarter, following a 25-basis-point September rate cut. The Fed noted a cooling labor market, decelerating (but still above‑target) inflation, and diminished economic visibility due to the U.S. government shutdown in October through November. The October and December rate cuts brought the target range down to 3.50%–3.75%. Policymakers characterized the moves as “risk‑management” cuts rather than an aggressive stimulus cycle, emphasizing data dependency and uncertainty around tariffs and fiscal policy.   

As we move into 2026, markets appear to be pricing in one to two more rate cuts as the Fed grapples with “normalizing” rates against a backdrop of still above-target inflation and the anticipated impact of pronounced fiscal stimulus. Bond markets appear to be adequately compensating investors for risk and reflective of current economic conditions.

Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).

Total return numbers for various fixed income indices over the past quarter and 12 months are below (data from Bloomberg).

Equities

Stock markets continued their march higher in the fourth quarter, finishing 2025 with another year of double-digit gains for most major market averages. The year was marked by heightened volatility, but ultimately markets looked past the unprecedented levels of policy shifts and saw earnings growth due to record high profit margins. The S&P 500 posted more than a 17% gain for 2025, marking the third straight double-digit gain for the storied market indicator and closing out one of the better three-year runs in its history.

The fourth quarter saw solid but modest gains across the board. There were, however, subtle changes in leadership, with value stocks slightly outdoing growth for the period. The quarter also witnessed international equities continuing their strong performance. Nearly all major market indices posted an exceptional 2025, as shown in the table below.

Driving the stock market higher was a combination of a resilient economy, continued profit growth, and Federal Reserve rate cuts. Most important of these as a driver of stock prices is earnings. For 2025, the S&P 500 appears to have notched another year of double-digit earnings growth, which is especially impressive in light of the uncertainties regarding tariffs and the government shutdown.

Although breadth has seemingly improved from its recent trends, the market is still largely powered by the biggest companies. The “Magnificent Seven” tech-related companies still account for over one-third of the S&P 500’s overall market capitalization, but performance among this cohort of stocks has become far more variable recently.

One of the more surprising stories of 2025 was the exceptionally strong performance of international markets. Emerging markets had their best year since 2017. Both the developed market and emerging market benchmarks posted gains of over 30% for the year. While not a favored asset class going into the year by many investors, foreign markets performed well due to a variety of factors including a weaker dollar and more spending on defense and infrastructure abroad. As we have mentioned in the past, better relative valuations have also played a part in outperformance once these catalysts began to manifest themselves.

After another year of strong share price appreciation, worries of an expensive market persist. The S&P 500 now trades at about 23 times its expected earnings over the next 12 months, well above its average multiple. IPOs are back in vogue and retail traders seemingly have had an outsized impact on single-stock moves. These conditions have often preceded a period of poorer returns looking forward.

While the extent of any “bubble” the market may be in is certainly up for debate, we can confirm that the overall stock market is expensive by nearly all valuation metrics versus historical standards. The question of a continuation of market gains centers on whether corporations can maintain their impressive revenue growth and high profit margins in the face of mounting uncertainties. While betting against corporate America for long-term investors has historically been a poor wager, the prospect for a bumpy ride ahead seems likely.

Below is a table displaying various equity index returns for the past quarter (data from Bloomberg).

Sector returns

Fourth-quarter sector returns were variable and perhaps more driven by stock-specific influences than seen in previous quarters. More sectors were positive than negative; however, only two of the 11 sectors of the market outpaced the S&P 500 for the period.

Health Care, which has been one of the poorer-performing areas of the market for the first three quarters of 2025, rebounded nicely in the fourth quarter and posted a double-digit gain as the potential for less government intervention in the sector seemingly calmed investors’ nerves. A rally in shares of Alphabet Inc. helped propel the Communication Services sector ahead of the market for the quarter as well.

On the flip side, Real Estate and Utilities were the biggest laggards for the quarter. Although the market broadened to a degree in the fourth quarter, these sectors are traditionally more rate-sensitive, and longer-term rates moving higher proved to be a headwind for these sectors.

For the full year 2025, Communication Services and Information Technology were again the biggest winners, as many of the AI-themed companies reside in these sectors. Industrials, Financials, and Utilities also proved to be solid performers, highlighting some of the broader participation seen as economic conditions remained favorable for 2025.  Real Estate, Consumer Staples, and Consumer Discretionary were all slightly positive for the year, but were the biggest relative laggards, as concerns over rates, inflation, and a potential weakening labor market weighed on these sectors.

As we move into 2026, many investors maintain hopes of broader stock market participation. Valuations appear lofty for some of the past years’ winners. Further, uncertainties still are present, and the ultimate outcome of many government policies remains unknown, meaning some of the lagging areas of the market may come back in favor due to their less expensive valuations and defensive characteristics.

The following table details S&P 500 sector total returns for the quarter (data from Bloomberg).