Market Update, Fourth Quarter 2025 - Resilience, Divergence, and Evolving Narratives

Market Update, Fourth Quarter 2025 – Resilience, Divergence, and Evolving Narratives

What Did We See?

U.S. Large Cap stocks, or the S&P 500 index, were up about 2.7% in Q4.
The developed market of Japan was up about 8.8%.
Europe and the U.K. were up about 5.9% and about 6.4% respectively.
Emerging Markets and Asia (Ex-Japan) were up about 4.8% and 4.3% respectively.
Global fixed income returns ended the quarter all up from 0.3% (Euro Gov.) to 3.0% (EM Debt).

Where Do We Stand?

While the pace of gains has slowed, the markets continued to defy the odds to again reach all time highs.
Valuations moved higher and still remain elevated versus historic averages with earnings growth still needed to support further gains.
Market participants continue to ignore the volatility around tariffs, global unrest and Fed Policy for the time being, which leads one to caution for what 2026 may have in store.
We remain in a position to weather future volatility with client holdings in Gold and U.S. Treasuries while looking to be more active in opportunities when they present themselves.

The fourth quarter of 2025 capped a year in which markets and the broader economy repeatedly defied consensus expectations. Despite tariffs, fiscal expansion, and a series of unorthodox policy interventions from Washington, the U.S. economy performed substantially better than many anticipated, and equity markets finished the year with positive results across major asset classes—a phenomenon some describe as an “everything rally,” the first since the pandemic era where virtually all major asset classes delivered gains.

This resilience reflects a confluence of factors: falling short-term interest rates, strong corporate earnings, optimism around technology and artificial intelligence, and market expectations that policy extremes will moderate. Global returns were broad-based, with U.S. sectors, emerging markets, and commodities all contributing.

U.S. equities posted modest but positive returns in Q4. Large-cap technology and communication services sustained momentum, while value and international stocks participated meaningfully. Emerging markets performed strongly, driven by Asia and Latin America. Fixed income contributed positively but unevenly. Falling Fed rates provided support, while rising long-term yields offset some gains, shaping a complex rate environment.

Economic Signals: Data Dichotomy & Labor Market Weakness

Third-quarter GDP growth was recently announced at 4.3%, yet unemployment is rising, hours worked are flat, and ADP saw a September and November payroll contraction. For the year, ADP saw a modest gain in employment of only about 430,000 jobs. Temporary distortions such as tariffs or EV sales timing may contribute, but rising productivity from AI adoption may also be a factor.

Layoffs were notable: 202,118 in 3Q25, the highest third-quarter total since 2020. Year-to-date cuts reached 946,426 (+55% YoY), the fifth-highest YTD total in 36 years, indicating a soft labor market even amid strong GDP growth.

Interest Rates and Policy Confidence

Since the Fed’s first rate cut on 9/18/24, the 10-year Treasury has risen ~50bps, contrary to historical patterns of lower yields following cuts. This may reflect investor concerns over fiscal sustainability, tariffs, or Fed independence. Policy shifts across major economies have further contributed to a complex global rate environment. This bear close watching.

Narratives in Focus: AI, Productivity, and Risk Assessment

AI and technology investments remain dominant. Institutional commentary suggests this trend is structural, though near-term repricing risks exist. Corporate Capex on AI has surged even as labor gains lag, highlighting a potential decoupling between investment and hiring.

Volatility and Market Behavior

It is important to remember that markets are not written in straight lines. In the 2022 Bear Market, the S&P 500 experienced significant volatility and declines due to high inflation, Federal Reserve interest rate hikes, and global economic concerns, marking a bear market (down 20%+) but not a sustained 25%+ drop for the whole year. Then again in April of 2025, a sudden, sharp drop occurred following new US tariffs, with the S&P briefly down over 23% from its February 2025 peak before a rapid recovery within weeks, noted as the largest decline since the COVID crash.

If you consider the 2025 drop to be an anomaly, we are now about 3½ years from the most recent “bear market”. However, we have some time before the 5-7 year cycle of 25% declines is upon us.

Historical S&P 500 declines since 1928:

1% declines: 50–60 times/year
3% declines: 7–8 times/year
5% declines: 3–4 times/year
10% declines: every 1.1 years
15% declines: every 2 years
20% declines: every 3½ years
25% declines: every 5–7 years

In Conclusion

We are in a new world of productivity transformations as AI-driven efficiencies take root in the broader economy. At the same time, GDP growth can coexist with softening labor markets for a time. The lag between AI investments (happening now) and the earnings gains from AI adoption (down the road) will likely determine whether or not the markets need to reset or not. The market is riding high on the investment cycle IN Artificial Intelligence right now. At some point we will need broader economic earnings to move higher FROM the adoption of AI. At the same time, rising long-term yields warrant close attention and could derail both cycles.

The fourth quarter of 2025 closed a year defined by resilience, narrative evolution, and macroeconomic divergence, underscoring the importance of disciplined planning, risk management, and diversified positioning.

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