By: Darren W. King | Wealth Management
Equity markets continued the rally in the fourth quarter with a quarterly S&P 500return of 2.68%. The story in the quarter was a 12% rally in the Health Care sector, while internet media stocks also posted a 7% return. The S&P 500ended 2025 up 17.86%. The Technology-heavy NASDAQ was up 21.17%, while the DOW Jones Industrial Average ended the year up 14.92% and represented more of an average return for large cap stocks in aggregate. The Russell 2000 Small Cap Index finished the year gaining 12.79% and was the laggard in 2025. International developed market equities, as measured by the Morgan Stanley Capital International Europe, Australasia, and Far East Index (MSCI EAFE), closed 2025up 32.03% in US dollar terms. The MSCI Emerging Markets Share Price Index closed the year gaining 34.29%. Money flow into international markets coincided with weakness in the US dollar as non-US assets gained increasing investor attention as a diversification tool after outsized gains in AI themes in 2025.
2025 witnessed consumer and real estate shares underperform while growth and technology sectors continued their advance. S&P 500 sector results for 2025: Telecommunications Services 33.55%, Technology 24.04%, Industrials 19.27%, S&P 500 17.86%, Utilities 16.04%, Financials14.97%, Health Care 14.59%, Materials 10.54%, Energy 8.67%, Consumer Discretionary 6.04%, Consumer Staples 3.90% and Real Estate 3.14%. Market beating returns were still concentrated in AI and technology themes with only 3sectors outperforming the S&P 500 in 2025. However, all economic sectors posted positive returns for the year.
Based on current consensus earnings forecasts, the forward 12-month P/E ratio for the S&P 500 is 21.8X, more expensive than the five-year average P/E of about 20X. Currently, the market is estimating 15% earnings growth on 7.2% revenue growth in 2026. Profitability remains high for S&P constituents, with net profit margins currently at 13.9%, compared to 5-year average profit margins at 11%, the highest profit margins since 2008. Accelerating profit margins have been a major reason for the equity markets’ recent rally off April 2025 lows. Average equity strategists’ bottom-up price targets for the S&P 500 in 2026 are at 8010, currently 15% higher than current trading levels and equal to 2026 expected earnings growth rate. AI data center initiatives have been a major source of the recent move by many Wall Street equity strategists to move S&P 500 targets higher over the past several months. Overall, “Magnificent 7” earnings are estimated to grow 22.7% in 2026 with all other S&P 500 constituents expected to grow earnings by 12.5%. The backdrop for equities in 2026 remains supportive for continued gains. We see a continued broadening of equity returns out of technology and into other areas of the market that have not participated as dramatically in the equity rally. Strategic moves out of domestic large capitalization investing into international stocks took center stage in 2025 as valuation discounts for international markets proved hard to ignore. Even after a stellar year for international stock returns, the Current P/E multiples for the MSCI EAFE is currently 18.5Xearnings while the MSCI Emerging Markets Index trades at 17.2X earnings. The weakness in the US dollar has also seen international investors diversify out of their overweight in the American economy.
The Federal Reserve cut the fed funds rate by 75 basis points in 2025, choosing to cut rates by an additional 25 basis points at their December 10 meeting, to a range of 3.75% to 3.5%. Looking out to 2026, they have indicated only one 25 basis point cut with one additional cut in 2027 and indicate a long-run neutral fed funds rate around 3%. The Fed cited slowing job creation as a greater concern than inflation within their current economic outlook. The Fed also indicated that growth is stable and the tariff hit to the economy has been less than expected. Today, with the fed funds effective rate around 3.64% and inflation around 2.7%; we enter 2026 awaiting a new fed chair in May and monitoring the economy to see if monetary policy will move more towards pro-growth initiatives and if inflation continues to move closer to the 2% target. In the short term, the fed remains positive for risk assets while also moving inflation much closer to their 2% objective. The Fed estimates full year 2025 GDP growth to be 1.7%, revised up from 1.6% in September and 2026 GDP growth at 2.3%, revised up from 1.8% in September. The median year-end unemployment forecast for 2025 and 2026 were unchanged at 4.5%and 4.4%. Core PCE inflation, the Fed’s preferred inflation gauge, was revised a touch lower to 3.0% in 2025 (previously 3.1%), and to 2.5% in 2026 (previously 2.6%). Personal consumption has rebounded to the 2.6% level from earlier estimates for 2025 spending around 1.6%, which has become a positive surprise after the slowdown in spending in the first half of 2025.
The 10-year treasury yield fell by 40 basis points in 2025, starting the year at 4.57% and ending the year at 4.17%, while the 30-year treasury ended 2025 up 6 basis points from the beginning of the year. Longest duration bonds underperformed shorter duration issues as yields remained more stable for longer maturities while shorter maturity yields moved lower following 2025 fed action. Long treasuries were up 5.59% in 2025, while intermediate treasuries were up 6.51%. In a risk-off trade and with the market’s comfortability for longer-run economic stability, higher credit quality underperformed the lowest credit quality issues. Aaa rated bonds within the Barclays U.S. Aggregate Index were up 6.87% in 2025, while Baa rated bonds returned 8.20% during the same period.
The Bloomberg Dollar Spot Index finished 2025 with the dollar having weakened 8.1%compared to our trading partners. International investors are forecasting slower growth and lower relative interest rates in the US following the election and no longer believe the US economy will outperform the rest of the world. Light crude oil futures were down roughly 20%in 2025, with WTI oil futures falling to $57.42 from $71.72 over the course of 2025. 30-year mortgage rates fell from 7.28% at the end of 2024 to 6.25% by the end of 2025, while 30-year treasury yields rose 6 basis points to 4.78% from 4.84%at the end of 2024.
According to the Bureau of Labor Statistics, the December jobs report showed 50,000 jobs added during the month, well below expectations for 70K in job gains. For 2025, monthly new job creation averaged 49k per month, slowing from the 168K monthly average in 2024. While 2025 was one of the weakest years for hiring since 2009, employers have largely refrained from layoffs. Service sector employment was most of the job gains, as manufacturing job growth remains weak, and job growth came solely from health care and hospitality hiring. The December jobs number reported unemployment at 4.5%, well off the cycle low unemployment rate at 3.5% in March of 2023. The labor force participation rate remained steady in December at 62.5%, up from the pandemic trough of 60.2% in April of 2020. For December, average hourly earnings rose 3.8% over the past year, below the recent wage inflation numbers that were averaging greater than 5% for most of 2023. In short, the August jobs number showed areal slowing in new hirings while businesses are still holding on to their current headcount.
Annualized retail sales, through October of 2025 (economic reports are still backlogged following the government shutdown), were up 3.5% over the past year, compared to the consumer price index’s measure of inflation up 2.7%. Sales were up strong in most categories, with only building materials and sales of other big-ticket items showing slowing trends. On the negative front, building materials and supplies were down 4.5% from the prior year. Furniture sales were up a modest .5% from the prior year. Auto sales were up 1.2%. However, the consumer is still spending on some discretionary items. E-commerce and mail-order houses ended the 12-month period with a 9% sales gain. Restaurant spending was up 4.1%, health care spending was up 5.7%, sporting goods and hobby spending was up 4.6% and clothing and accessories were up 5.7%. With consumer spending two-thirds of our economy, retail sales through the first 10 months of 2025 surpassed all expectations and accelerated strongly from the early 2025 slowdown in spending. In short, the consumer remains resilient despite the slowdown on spending on big-ticket items related to the housing and auto market.
We move into 2026 constructive on equity prospects for the year. Two of the limiting factors for equity returns; rising rates and slowing growth appear to be of limited concern at the present. Corporate tax cuts, accelerated deprecation incentives for capital expenditures, continued AI server spend, and historically high profit margins should drive further gains despite slightly elevated equity valuation levels domestically. We continue to favor cyclical sectors over defensive stocks and advise the continued diversification into a larger international allocation. We continue to focus on equities that benefit from AI technological advances, continued deregulation within financials, and value in the health care sector as Obamacare subsidies have been extended despite earlier worst-case fears. We continue to deemphasize consumer sectors with the expected continued pullback in retail spending levels and have taken some profits after the huge runup in technology names in 2025. With earnings growth rates in 2026 somewhere in the 12% to 15% range; we see equity returns moving lockstep with continued earnings momentum.
Within the fixed income markets, interest rate, fed policy, and market traders see two more twenty-five basis point interest rate cuts in 2026 and 2027 and a neutral fed funds rate around 3% in the longer-term. The issue is how much inflationary pressure will the trade war induce from here. Our outlook is for interest rates to remain stable at current levels in 2026. We remained strategic and active in the bond market earlier in 2025 when rates peaked. For reference, the 10-year treasury reached 4.6% in May and is now trading at 4.18% on January 8. We are taking a wait and see approach to further bond purchases after the swift movement down in yields, especially on the short end of the yield curve. With bond maturities and reinvestment, we are extending duration and buying longer-dated maturities. If the economy falters with tariff pressure and a cost weary consumer; the Fed has ample room to move rates lower from current semi-restrictive Fed fund levels at 3.65%, to a level closer to the current 2.7% inflation rate. Bond allocations would provide a hedge to any equity market weakness should a slowing economy unfold.
Click here to read the Q4 2025 Market Summary.
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Data Sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Dept. of Commerce (GDP, retail sales, housing); Institute for Supply Management (manufacturing/services). Factset (S&P 500 statistics); Performance: based on data reported in Bloomberg (indexes, oil spot prices, foreign exchange); News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources, such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied upon as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
