Quarterly Update

Although the stock market closed the fourth quarter (Q4) with a bit of a whimper, last year was a good one. We saw surges of volatility throughout, especially in the second quarter, but much of the year was surprisingly quiet (at least in terms of volatility) and productive, with major indexes gaining double digits. The evolving AI landscape continued to lift markets while news of tariffs and shifting expectations for interest rates acted as counterweights. Myriad issues impacted investor psychology during the year, such as federal government layoffs, a federal shutdown, and potential problems at the Social Security Administration, but these didn’t have a direct impact on markets.

Here's a summary of how major market indexes performed during the quarter and for the year, respectively.

• US Large Cap Stocks: up 2.4% and up 17.7%
• US Small Cap Stocks: up 2.3% and up 12.7%
• US Core Bonds: up 0.5% and up 7.1%
• Developed Foreign Markets: up 4.8% and 31.6%
• Emerging Markets: up 5.5% and 34%

US stocks had a respectable Q4 and solid 2025. While it seemed like anything related to AI rose during the year, actual performance was mixed. The so-called Magnificent Seven stocks were up nearly 28% for the year as a group, but that average return spans Alphabet (Google) rising over 65% to Amazon climbing about 6%. Collectively these mega-cap stocks comprise over a third of the benchmark S&P 500’s market value, so their outperformance lifts the market average. At least within indexes containing a large weighting to these stocks. Indexes that don’t, such as the Dow 30 and others that organize holdings equally instead of by company size saw returns last year of 14% and around 10% or 11%, respectively. Across sectors, Tech and Communication Services, where most of the AI exposure resides, each rose by over 20% last year while most other sectors were up by the mid-teens. Only two of the eleven sectors, Consumer Staples and Real Estate, were down on the year but only by around 1%.

While US stocks got most of the news, foreign markets outperformed handily. This followed years of underperformance and was primarily driven by the US dollar having its worst year since 2017. Also, better stock valuations and fiscal stimulus by foreign governments helped, and massive investment in AI benefitted certain Asian markets. Tariff announcements by the Trump administration during April also helped, albeit indirectly. Tariff concerns were percolating in the markets as 2025 began, allowing foreign stocks to outperform during the first quarter. Then April hit and foreign markets were seen as a haven while the US market experienced a correction. Markets quickly rebounded in the US, losing less than a percent during April after being down nearly 15% at one point. But at their worst in April foreign stocks, as measured by the MSCI EAFE index, were only down about 3%. That was a springboard for the rest of the year that otherwise tracked with the S&P 500. Gold and other precious metals also benefited from some of these issues. A common fund tracking major metals returned almost 70% for the year and silver rose by a whopping 145%. These returns also reversed multi-year periods of underperformance.

Tariff-related fears largely subsided over the following months as the Trump Administration repeatedly backpedaled from its original sweeping tariff plans. This allowed investors to mostly look beyond recession fears that appeared overnight during April. The focus shifted to the seemingly more pressing issue of the Federal Reserve’s interest rate policies. Markets had “priced in” multiple rate reductions by the Fed during 2025 and investors mostly got what they wanted. The Fed reduced short-term rates by a quarter point three times, which lowered borrowing costs for some in the economy and helped provide a tailwind for the stock market. But longer-term rates, which the Fed doesn’t directly control, rose into year-end and kept borrowing costs on mortgages, for example, stubbornly high. As of this writing, the Fed is expected to lower rates again maybe twice in 2026, but that’s a moving target. These shifting but generally positive expectations also helped the core bond market, which returned around 6% to 8% in 2025, depending on maturity period and issuer type.

Otherwise, we begin 2026 with low risk of recession and analysts, at least on average, are targeting around a 10% annual return for the S&P 500. They’re slightly more bullish for this year than usual and that’s mostly due to the economic tailwind from massive AI-related investment lasting a while longer – maybe that’s Pollyannish but that’s the environment we’re in – excesses can last awhile. So, we should take these predictions with a grain of salt and some even see them as a contrarian indicator. Still, it’s helpful to know what Wall Street is expecting.

While I’m optimistic about 2026, it’s prudent to expect amped up market volatility. Analysts are bullish on stocks and that’s great, but retail investors have been bearish on the markets and economy for some time, even as markets trended higher. How much of this is based on headlines that have little directly to do with the markets is debatable. But there’s no doubt that uncertainty around social, financial, and economic issues is elevated in many households and boardrooms around the world. That’s nebulous as a catalyst but fosters an environment where larger market swings are just a headline away, so be prepared for it. The financial side of preparedness is straightforward, involving carefully and continually reviewing your portfolio for rebalancing opportunities while ensuring your money is always in the right place. The emotional side is harder, of course, and is why being a long-term investor is so difficult.

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