Latest Thoughts

Key Takeaways, Fourth Quarter 2025

Assisted by the Fed’s rate cuts in October and December and despite the government shutdown, the broad US stock market extended its gains returning 2.4%. The small cap Russell 2000 gained 2.2% and bond markets had modest positive returns.

Economic uncertainty remains elevated and growth has softened. Not all the economy’s segments are recovering at the same rate, resulting in a “K-Shaped” recovery. In addition, due to after-effects of the shutdown there is uncertainly about economic data. The implications of the news and data were mixed. The stock market continued to diverge from the “real economy” (solid gains vs tepid growth). Surveys and sentiment were weaker than economic reports. AI stocks performed inline with the broader market after leading over the first three quarters.

The Fed cut rates in October and December pointing to signs of a weakening job market. Chairman Powell described the Fed as taking a balanced approach to address both inflation and employment risks. The Fed remains committed to its 2% inflation target. The yield of 3-month Treasuries fell 37 bps; down 70 bps YTD. The yield of the 10-year Treasury rose 2 bps. Credit spreads changed little.

Equities

The US stock market continued the rally of the first three quarters, with the broad market gaining 2.4%. The index was up 17.1% for the year, 22.2% per annum for the last three years, 13.1% for five, and 14.3% for ten.
Breadth continued to be narrow. IT, Communications and related stocks led, while Consumer stocks lagged.
After outpacing the market for the longer periods, Growth stocks lagged in Q4. The Russell 1000 Growth Index rose 1.1%. Small Caps lagged in Q4, and over longer horizons.
Both Developed international and Emerging Market stocks led the US in Q4. Developed returned 4.9%, and EM 4.7%. Aided by a weaker dollar, Developed were up 31.2% for the year, and EM were up 33.6%.

Fixed Income

Bonds: After starting the rate cutting cycle in September, the Fed cut rates again in October and December. Investors expect 1 or 2 cuts in 2026.
At the short-end, the yield on 1-year Treasuries fell 20 bps in Q4. For longer bonds, the yield of 5-year Treasuries fell1 bps, while 10-year and 20-year yield rose 2 bps and 8 bps.
Treasury yields were still down for the full year. The 1-year 68 bps, 5-year 65 bps, 10-year 40 bps, and 20-year only 7 bps.
Credit spreads were little changed, so bonds returns were generally in line with their yields. Core bonds gained 1.1% in Q4, Investment Grade Corporate bonds .9%, and High Yield 1.3%. For the year, they were up 7.3%, 7.8%, and 8.6%.