Strong Returns, Narrow Leadership: Markets Enter 2026 on Solid Ground

U.S. equities delivered another solid year in 2025, with the S&P 500 posting a high-teens total return and extending what has now become a multi-year run of strong gains following the 2022 decline. This performance came on the heels of two already robust years in 2023 and 2024, leaving the index meaningfully higher over the past three years. While headline returns were impressive, they again masked a familiar theme: a significant share of the gains came from a relatively small group of large, technology-oriented companies. Outside of those market leaders, returns were still positive but more moderate, underscoring that the market’s strength was real, though unevenly distributed.

December provided a fitting close to the year. After several consecutive monthly gains, equity markets finished essentially flat. Rather than signaling weakness, this consolidation reflected a market that had already absorbed a great deal of good news and was comfortable holding near record levels. Capital largely stayed invested, equity flows remained supportive, and leadership continued to rotate, even as participation narrowed somewhat toward year-end.

One of the more notable features of 2025 was that despite the strong gains in the market, equity valuations remained high but stable as productivity gains and the outlook for earnings growth remains robust. The rapid adoption of artificial intelligence across a widening range of industries is strengthening confidence that efficiency improvements are beginning to show up in corporate results, supporting higher valuations.

That optimism is reinforced by a significant increase in capital spending, particularly tied to AI infrastructure. Investment in data centers, semiconductors, power generation, and related technologies have become a meaningful driver of economic activity, helping offset areas of the economy that might otherwise have been more sensitive to policy uncertainty.

The Federal Reserve remained an important part of the market narrative throughout 2025, though more for its guidance than for abrupt policy shifts. After delivering multiple rate cuts during the year, the Fed struck a more patient tone following its 25-basis point cut in December, emphasizing that future decisions would depend on continued progress on inflation and evidence of balanced economic growth. Markets, meanwhile, have begun to price in the possibility of two to three additional cuts in 2026, a view that may also reflect expectations that a more dovish Federal Reserve chair could succeed Jay Powell when his term concludes.

Policy and geopolitical risks dynamics have shifted since earlier last year. Trade and tariff headlines tied to the Trump administration persist, but markets are showing reduced sensitivity as investors reassess both the likely scope and practical impact of potential changes. At the same time, a rapidly evolving geopolitical landscape is leading to increased defense and security investment in both the United States and Europe, translating into tangible spending and earnings opportunities rather than broad-based risk aversion.

Concerns around labor availability—particularly those related to retiring baby boomers and immigration policy—is proving to be more muted than many expected. Productivity gains, technology adoption, and evolving work practices are helping businesses operate efficiently, easing pressure from a tighter labor supply. Despite affordability challenges in certain areas, wage growth remains supportive, job losses are limited, and consumers largely continue to spend. The labor market is showing signs of cooling without exhibiting the broader stress typically associated with economic downturns.

Credit markets reflect this underlying stability. Episodes of stress during 2025 were largely idiosyncratic and did not spread into broader funding or liquidity concerns. Overall credit conditions remain orderly, reinforcing the view that the financial system entered 2026 on solid footing.

Looking ahead, we remain optimistic about the long-term potential of artificial intelligence and the productivity gains it can deliver across the economy. At the same time, elevated valuations increase the likelihood of periodic volatility, particularly as expectations evolve and leadership shifts. Dislocations should be expected along the way, even if the broader growth and productivity story remains intact.

As always, our focus remains on maintaining disciplined, diversified portfolios aligned with long-term goals rather than short-term market narratives. Periods following strong multi-year gains often reward patience and thoughtful risk management more than aggressive positioning. We will continue to monitor economic trends, policy developments, and market conditions closely and make adjustments as warranted.