Monthly Market Summary
2025 began with the stock market hitting new highs in February, only to reverse sharply as trade policy uncertainty triggered a nearly -20% sell-off. However, the sell-off set the stage for one of the strongest recoveries in decades. Fueled by AI enthusiasm, rate cut expectations, strong corporate earnings, and resilient economic growth, the S&P 500 set more than 35 new highs through year-end.
The S&P 500 finished 2025 with a nearly +18% gain, its third consecutive year of double-digit gains. It’s been an impressive run that included a global pandemic, aggressive rate hikes, and the rise of AI. Through it all, the stock market’s gains have been supported by solid economic growth and strong corporate earnings.
Stocks closed out the year with another quarter of gains, building on their momentum from earlier in the year. The S&P 500 gained +2.7% in Q4, bringing its year-to-date return to nearly +18%. The Nasdaq 100, an index of leading tech companies, gained +2.5%, raising its full-year return to +21%. Those headline returns were constructive, but the main development was a shift in market leadership. Large-cap value proxies led the market, with the Dow Jones Industrial Average and the Russell 1000 Value each gaining approximately +4.0%. The Russell 2000 gained +2.2%, with small-cap stocks rallying to new highs as the Fed cut twice.
Despite solid gains across the stock market, the pace of the rally continued to slow from the second and third quarters. Sector breadth also remained narrow, with only two S&P 500 sectors outperforming the broader index. Health care was the top-performing sector, benefiting from renewed interest amid increased AI scrutiny and a pause in tech leadership. The sector’s defensiveness and improved earnings stability were catalysts, but the quarter wasn’t defined by a flight to safety. The defensive trio of real estate, utilities, and consumer staples were the weakest sectors, signaling limited investor concern about the economy.
The shift in market leadership was modest, but it was notable. The percentage of S&P 500 companies outperforming the index has hovered around 30% the past three years. Those are significantly below the historical average of 49% and the three lowest years since 2000, illustrating how a small group of stocks has driven the S&P 500’s gains. The Q4 rotation occurred as the Fed cut interest rates twice, a move that the market believes will ease pressure on companies. Meanwhile, the AI trade in the stock market is becoming more selective as it enters its fourth year. The combination of lower interest rates and increased AI scrutiny could create opportunities for new leadership. If more companies start to outperform, it will represent a significant trend change in the market.
International stocks continued to outperform U.S. stocks, extending their gains from earlier in the year. Both developed and emerging market indices gained nearly +5% in Q4. For the full year, they each gained over +30% and outperformed the S&P 500 by more than +13%. Their outperformance isn’t a case of U.S. weakness, with the S&P 500 gaining nearly +18%, but rather broad international strength. A weaker U.S. dollar played a significant role, with the softness driven by rising trade tensions, policy uncertainty, and a rotation toward international stocks.
Credit Market Recap – Bonds Trade Sideways
The bond market was relatively quiet in Q4. The focus centered around the Fed’s rate cut plans. Yields on shorter maturity U.S. Treasury bonds fell as the Fed cut twice, while longer maturity yields ended the quarter modestly higher as economic activity remained solid and inflation remained stuck near 3%. Overall, the bond market has transitioned from a source of volatility during the Fed’s 2022-2023 rate-hiking cycle to relative stability and a source of income in 2025. Changing rate cut expectations and economic uncertainty have triggered periodic volatility, but the overall path has been smoother.
Corporate bonds traded higher in Q4. Credit spreads widened during periods of stock market volatility, but the moves were orderly and short-lived. The investment-grade and high-yield bond markets showed few signs of stress, and default expectations remained low. Both investment-grade and high-yield gained roughly +1% for the quarter, capping off strong full-year returns of approximately +8%.
The municipal asset class underperformed taxable fixed income, with the investment-grade index underperforming US Treasuries and high yield municipals underperforming high yield corporates. Historically high supply paired with tepid demand, especially further out the curve, were main drivers, though notably, within the tax-exempt space, there was also a dispersion in quality returns. Investment grade munis outperformed high yield this year, with most of the outperformance occurring in the second half of the year. This development serves as a reminder that risk management in the lower quality space is paramount. Overall municipal credit spreads remain compressed by historical standards, calling for selectivity to capture the high overall yield levels within this part of the market in a prudent fashion.
As the new year begins, credit spreads remain tight by historical standards. Investment-grade and high-yield spreads are at their tightest levels in decades, signaling investor confidence in corporate fundamentals and the economy. While spread tightening has supported corporate bond returns, it means valuations are no longer cheap. Corporate bonds offer compelling yields for income-focused investors, but they also come with important trade-offs. When spreads are this tight, there’s less margin of safety if earnings or economic growth disappoint. For investors, it’s important to balance the income potential with credit risk.
2026 Outlook – Market Strength Raises the Bar
Looking ahead, the bar is now higher. Today’s starting point is very different than a few years ago, or even last year. Stock valuations are more expensive, credit spreads are near their tightest levels in decades, and expectations for earnings and economic growth are high. None of these are red flags on their own, but they frame a market that already prices in rate cuts, strong earnings, solid economic growth, and the AI industry’s growth. The combination doesn’t necessarily signal a stock market sell-off, but it leaves less room for positive surprises.
Despite the higher starting point, there are many positives. The tech sector is experiencing a wave of innovation not seen since the internet era of the late 1990s. Companies are generating record profits. The S&P 500’s earnings grew by double digits the past two years, with expectations for solid growth in 2026. Consumers, the engine of the U.S. economy, continue to spend. We believe interest rates will remain on pause near-term but are likely coming down, which could unlock economic activity that higher rates delayed the past few years. Financial markets are open and functioning with more IPO filings and M&A announcements. Finally, there’s no clear sign of systemic stress.
Procyclical Twin Engine Policies (Fiscal/Monetary). Fiscal policy has been heavily front-loaded, with potential Big Beautiful Bill benefits expected to materialize in 2026/2027. CapEx spending remains robust, taking advantage of accelerated depreciation and providing ongoing support for GDP growth. At the same time, monetary policy is shifting to easing in response to softer labor markets. Consumers are also likely to benefit from additional tax savings.
Inflation and Labor to Stabilize. The Fed views policy rates through its Phillips Curve framework, connecting wage inflation to the unemployment rate. The Fed believes today’s labor markets are not dynamic, and sees the risks tilted to higher unemployment, implying downward pressure on inflation. Thus, cutting rates, despite inflation sitting above target, is warranted.
As we turn the page to 2026, it’s important to keep the big picture in mind. Markets have delivered impressive returns over the past five years, but each year brings its own surprises. We can’t predict what lies ahead, but we believe a disciplined approach focused on long-term goals, thoughtful diversification, and risk management are the best ways to navigate the market. The Investment Office will continue to closely monitor incoming economic data, fundamental earnings, evolving market trends and macro polices to help ensure portfolios remain aligned with long-term objectives, regardless of what the market does in the short term.
International Pro-Growth Polices. U.S. tariff polices have ignited reindustrialization efforts in Europe, led by Germany, which is now spending on fiscal stimulus comparable to the period following German Reunification. The transition is underway, where infrastructure, defense and financials stand to benefit. We believe with inflation now tamed, European Central Bank (ECB) policy is likely to remain accommodative.
Q4/2025 Equities
In the final quarter of 2025, equity markets across the globe continued to rise, though U.S. markets lost some steam in the last two months. Since the summer, the market has placed its hopes on two things: (i) the AI trade, and (ii) the Fed to continue to cut interest rates by focusing more on the sluggish labor market and ignoring the fact that inflation still hovers well above its 2% target. Both hopes came true during the quarter, though not without some volatility. AI stocks saw significant drawdowns during the quarter, while Bitcoin, a bellwether for momentum and risk-taking saw a 32% drawdown over a six-week period. Market breadth improved on the back of a strong earnings season with the S&P 500 Equal Weight index outperforming the S&P 500 in November and December. The S&P returned 2.7% in 4Q25 (+17.9% YTD) and ended the year just off its all-time high; mid cap stocks returned 0.2% (+10.6% YTD) while small caps returned 2.2% (+12.8% YTD). Within the S&P 500 index, healthcare (+8.4%) and communication services (+8.1%) were the best performing sectors; the interest rate-sensitive real estate (-2.8%) and utilities (-2.3%) sectors were the laggards and only one with negative returns. International markets have benefited from a falling U.S. dollar year-to-date. During the quarter, EAFE markets returned 4.9% (+31.2% YTD) with the U.K. (+7.1%) and Europe (+6.2%) leading; EM returned 4.7% (+33.6% YTD) led by another stellar quarter in Korea (+27.3%), and strong performance from Brazil (+7.0%) and India (+4.8%) while China (-7.4%) was the key laggard.
From a valuation perspective, the S&P 500, NASDAQ, EAFE and EM trade at or above +1 standard deviation based on historical forward P/E ratios with the S&P 500 at +1.8, NASDAQ at +1.2, EAFE at +1.1 and EM at +1.1. For the next 12 months, EPS growth for S&P 500 is expected to be 11.3% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 21.2% (vs. 10.7% annualized over the last 20 years). Equities across markets caps in the U.S., and in non-U.S. developed and emerging markets, trade at or above their 20-year averages based on forward P/E ratios.
Q4/2025 Fixed Income
Investment grade fixed income had positive returns for the quarter as the yield curve steepened with rates falling at the short end of the curve and rising modestly a 10-year tenure and longer. For the quarter, municipals returned +1.7% (+5.9% YTD), the Bloomberg Aggregate Index returned 1.1% (+7.3% YTD) and investment grade corporates returned 0.8% (+7.8% YTD). High yield bonds returned +1.3% (+8.6% YTD) while leveraged loans returned +1.2% (+5.9% YTD). Emerging Market debt returned +4.7% (+13.6% YTD) as spreads compressed 57bps and as the dollar rose 0.6% in the quarter.
Q4/2025 Rates
The yield curve steepened as the short end fell in response to Fed rate cutting. During the quarter, the recession-watch 3M-10Y spread widened 32bps to +53bps. The 2Y-10Y spread widened 15bps to +69. Rates rose in other developed markets but fell in the U.K. The spread between Italian and German 10Y bonds compressed 12bps to 0.70%. 5-year breakeven inflation expectations fell 18bps and now sit at 2.27% (low of 1.88% on Sept 10, 2024); 10-year breakeven inflation expectations fell 12bps and now sit at 2.25% (recent low of 2.03% on Sept 10); the 10Y real yield rose 12bps to 1.90%. For 2026, the market expects between 2 and 3 cuts vs. the Fed’s guidance of 1 cut. At year-end 2025, the market expects the Fed Funds rate to be 3.04% vs. the Fed’s guidance of 3.25%-3.5%.
Q4/2025 Currencies/Commodities
The dollar index rose 0.6% in the quarter; in 2025 the dollar fell 9.4%, its worst drop in nearly a decade. The commodities complex gained 1.0% (+7.1% YTD) even as energy prices fell 5.0% in the quarter (-5.1% YTD) driven by precious metals (Gold (+11.9%, +64.6% YTD), Silver (+53.6%, +148.0% YTD) and Copper (+17.0%, +41.1% YTD). Brent oil fell 9.2% (-18.5% YTD) to $61/bbl. US natural gas prices rose 11.6% (+1.5% YTD) while European natural gas prices fell 10.4% (-34.7% YTD).
Q4 Market monitors
Volatility fell for equities (VIX = 15) and for bonds (MOVE = 64). Market sentiment remained at +3 to end the quarter, recovering from some spells of pessimism during the quarter.