Happy New Year!
A year ago, few market prognosticators projected a third consecutive year of double-digit gains for the major equity indices in 2025. Many were still forecasting a recession that had eluded them in both 2023 and 2024. As it turned out, 2025 delivered a broad-based, all-asset bull market—surprisingly led by Gold (+64%) and International Equities (Developed +32%, Emerging Markets +34%).
Less surprising was the fact that the dominant driver of U.S. equity gains was, once again, artificial intelligence and the Magnificent 7. For perspective, according to MarketWatch, of the S&P 500 Index’s roughly 17% total return in 2025, an estimated 10–13 percentage points came from the concentrated performance of AI-driven mega-cap technology stocks. The remaining 4–7 percentage points were contributed by the other 493 companies in the index.
This concentration made 2025 a particularly difficult year for active money managers to outperform. Doing so would have required abandoning diversification—the cornerstone of prudent risk management—in favor of heavy concentration in a narrow subset of market leaders.
Looking ahead, the market enters this year in rarefied territory from a valuation standpoint. The S&P 500’s forward P/E ratio of 22.8 has only been higher twice in modern history — during the dot-com bubble and the immediate post-COVID rebound. More concerning, equities appear expensive not only in absolute terms but also relative to the duration of this bull market. Record-high profit margins may offer some justification for today’s premium valuations, but that rationale is wearing thin.
How did we get here? When this cyclical bull market began on September 30, 2022, valuations were already elevated, though offset by exceptionally strong profit margins — roughly 2.5 percentage points above the prior record set in 2011. Supporters of high valuations argued that the “Magnificent 7” and AI-driven profitability made such multiples defensible – and they were right. That argument has since weakened. Over the past three years and three months, the S&P 500 has surged 91%, the strongest gain among the seven post-war bull markets lasting 39 months. Yet during that time, earnings growth ranked only fourth of seven. The result has been the largest P/E expansion of any comparable cycle — a clear signal that price gains have far outpaced earnings power. History suggests that further multiple expansion from here may prove difficult.
We remain, therefore, what we would call cautious bulls —increasingly vigilant toward the risks that tend to emerge in the fourth year of a bull market.
Be well,
Mike
Sources: Addepar, BCA Research, Bloomberg, MarketWatch, Ned Davis Research, Robertson Stephens Investment Office