2025 served as a defining case study for the myriad challenges of market timing. Despite trade shocks, geo-political unrest, and policy uncertainty, long-term investors were rewarded for their patience as the S&P 500 achieved its third consecutive year of double-digit gains (page 35). The S&P 500 Index finished the year +18%, which is 40% above April’s low following the US tariff announcements. Selling during April’s market volatility and missing just the S&P 500’s ten best days during 2025 would have flipped that 18% gain into a 12% loss. This scenario also reinforces that money needed in the short-term should not be held in equities. Stretches of market volatility are typically sparked by something unexpected (Liberation Day, Coronavirus, etc.), pushing unprepared investors without a diversified portfolio to scramble and make short-sighted decisions. We often tell clients that when preparing for a journey, we cannot predict the weather, but we can be sure to build the right boat. From an investment standpoint, we believe that means determining the appropriate long-term asset allocation based on liquidity needs, risk tolerance and time horizon, rather than trying to time the market in the short-term.
The US economy, as measured by GDP, grew a healthy 2.3% in the third quarter of 2025 versus a year ago (page 8). We believe the US consumer remains stronger and more resilient than what consumer sentiment readings would suggest (page 16). Household balance sheets remain healthy, particularly for those households that have benefited from the rise in home values and other financial assets (page 17). Real wage growth has remained robust, the unemployment rate remains near historically low levels at 4.4% (page 10), and the economy continues to produce jobs (albeit at a slower rate). And tailwinds from fiscal stimulus should persist into 2026, further supporting consumer spending. Business spending has also impressed, thanks in large part to significant investments in artificial intelligence. In 2026, we expect the economy to grow in line with the 2% trend we have seen historically, though we acknowledge there are no shortage of risks which could derail the expansion. The risk of a monetary policy misstep remains front and center, as the Fed balances lowering rates to help a slowing labor market and lower-income households while also keeping inflation from re-accelerating. Further escalation in geopolitical tensions surrounding Ukraine, Venezuela, and Taiwan, among others, could disrupt the economy and markets, depending on what unfolds. For now, financial markets are riding a strong economy that bodes well for continued consumer spending and future corporate earnings.
Against this economic backdrop, equity market performance was strong in 2025. US Large Cap Equities, as measured by the S&P 500 Index, finished the year at +18% (page 21). S&P 500 earnings are expected to have grown nearly 12% in 2025 driven by higher revenues and wider profit margins, and expectations call for 15% growth in 2026 and 2027 (page 23). These expectations may be overly optimistic in an economy with 2-3% growth and inflation, but this is nonetheless a testament to the resilience of US businesses. We are concerned that equity prices continue to rise faster than earnings, driving valuations higher. The S&P 500’s 12-month forward price-to-earnings ratio is currently at 22x (its long-term average is 16-17x, page 22). Valuations are even more extreme in the largest 10 US companies, which now account for a record 41% of the S&P 500 index. These 10 companies trade at 28x forward earnings, while the other 490 remaining stocks trade at 19x. There is an argument to be made that the quality of these companies, as seen by their consistent secular earnings growth, higher return-on-equity, etc. warrants a higher multiple. But history tells us that eventually, incredibly high valuations and growth expectations can lead to disappointments and devaluations. We believe this dynamic may not only create risks to traditional market cap indexing going forward but also create opportunities within the rest of the market. US Mid Cap Equities (S&P 400 Index) and US Small Cap Equities (S&P 600 Index) returned +8% and +6% respectively in 2025, failing yet again to keep pace with their larger counterparts. Small businesses are facing uncertainty from both a policy and regulatory standpoint, which has tempered future earnings expectations. Additionally, these smaller companies are typically more negatively impacted by higher interest rates than their larger counterparts. But at 15-16x forward earnings, paired with a strong backdrop for economic and corporate earnings growth, we believe these asset classes provide compelling opportunities for long-term investors. We remain Neutral weight to US Large, Mid and Small Cap Equities in our asset allocation models.
International equities outperformed their domestic counterparts by the largest margin in over 30 years (page 34). Non-US Developed Market Equities, as measured by the MSCI EAFE Index, finished the year +32% while Emerging Market Equities, as measured by the MSCI EM Index, finished the year +34%. The strong performance was a result of a weaker US dollar, which boosted returns for unhedged US investors; lower starting valuations compared to the US market; and resilient global economic growth. Earnings growth is broadly expected to continue across these markets (page 33), and additional fiscal spending measures coming in 2026 should further support these asset classes. Valuations have moved higher following the strong price performance in 2025, but the starting point was so low that the current 13.5x to 15.5x forward price-to-earnings multiples still represent relatively attractive valuations. We remain Neutral weight on Non-US Developed and Emerging Market Equities.
The Federal Reserve continued its policy easing efforts in December, even if not as fast as the President or markets wanted. The Fed cut its benchmark interest rate by a quarter point to a range of 3.5% – 3.75%, marking the third cut in 2025 and sixth cut overall this cycle (page 25). As tariff costs work through the economy and inflation remains stubbornly above the central bank’s 2% target (page 18), we believe the Fed should pause further cuts until more labor and inflation data come through, particularly after the surveys were delayed by the government shutdown. Despite the cut to short-term rates, stronger-than-expected growth, paired with continued concerns about the US government’s fiscal outlook, has kept long-term interest rates higher (page 27). We continue to take advantage of this opportunity, purchasing high quality bonds at attractive yields to lock in income in client portfolios. Our investment team has focused on generating consistent cash flow from the fixed income portion of client portfolios, whether through coupon income or consistent maturities. This cash flow is not only useful in managing client liquidity needs but also in helping protect against the risk of rising interest rates as the cash gets reinvested at higher market rates. We remain Overweight to high quality Investment Grade credits, including Municipals, Treasuries, Treasury Inflation-Protected Securities and Corporates. While Non-Investment Grade bonds enjoyed another year of positive returns (+9% as measured by the Bloomberg US Corporate High Yield index), credit spreads have tightened to historically narrow levels. Even though the income may be attractive on an absolute basis, we do not believe investors are being adequately compensated for taking excessive credit risk and have moved further Underweight to Strategic Bonds.
After the last several years of double-digit market returns (both positive and negative), market pundits are forecasting more “average” returns of 5-10% for equity markets in 2026. Despite the S&P 500 delivering an average return of ~10% since 1926, these average returns are rarely experienced in a given year. The market has returned close to the average (between 8% and 12%) in only 6 of the past 100+ years. Most years, the index’s return was outside of that range – often above or below by a wide margin – with no distinct pattern and little correlation to market forecasts and/or expected geopolitical impacts. The last several years have been no different. While we cannot predict what 2026 will bring, we do feel good reviewing portfolios with clients and continue to focus on the “blocking and tackling” of successful long-term investing: rebalancing portfolios to target allocations; managing fixed income duration and increasing income; and deploying cash balances effectively.