Fourth Quarter 2025 Market Review

We start with a hopeful Happy New Year to you and your loved ones, and sincere wishes for a year of good health, filled with joy and peace.

Year-End Results

The major indices ended the year near record levels, although the Santa Rally sputtered in the last week of trading.

The Not-So-Magnificent 7?

For the first time in a long time, the “Magnificent 7” did not outperform the broader index, with only Alphabet (GOOGL) and Nvidia (NVDA) gaining more than the S&P 500.

However, the Communications and Information Technology sectors still outperformed the index along with Industrials.

The result of this is that the Cap-weighted index outperformed the equal-weighted index again, but with a much smaller spread than last year, when the Cap-Weighted Index return was more than double the Equal Weighted Index. Most of the excess gains occurred in the second half of the year, after the Tariff Tantrums had faded and the Fed began lowering the benchmark overnight rate.

Speaking of the Fed

In their final meeting of 2025, the Fed cut interest rates by 25 basis points, leaving the target federal funds rate in a range of 3.5% to 3.75%.
While the Fed acknowledged that inflation “remains somewhat elevated,” it said that “downside risks to employment” were the reason for lowering interest rates.

Nine of the 12 voting members voted in favor of the 0.25% rate cut. But three voters dissented – the most since 2019.
Fed Governor Stephen Miran once again voted for a 0.50% cut. In contrast, Chicago Fed President Austan Goolsbee and Kansas City Fed President Jeffrey Schmid both voted to hold rates steady. However, a week later, Goolsbee stated “there’s a lot to like” in the latest consumer price index data, and if it can be sustained, it will help open the door for more interest rate cuts next year.

Altogether, six of the 19 Fed officials (including nonvoters) favored no cut at the meeting, while one (Miran) wanted interest rates even lower.

The Fed also announced that it would begin buying $40 billion in short-term Treasurys to ease stress on money markets and added that purchases will “remain elevated” for a few months. The move follows the Fed’s decision to halt its balance sheet runoff and is designed to “prevent stress in overnight funding markets.” The central bank emphasized that these purchases are technical in nature and do not signal a broader shift in monetary policy stance.

For what they’re worth, the Fed also released its quarterly Summary of Economic Projections. The Fed sees inflation, as measured by the personal consumption expenditures price index (PCE), coming in at 2.9% for 2025, slightly below its September estimate of 3%.

The Fed sees the unemployment rate remaining at 4.5% through the end of the year, unchanged from its September projection.
While those projections were the same as or better than the past updates, they’re worse than the inflation (2.4%) and unemployment (4.3%) rates the Fed projected for 2025 at the December 2024 meeting.

The Fed has a terrible history of making accurate predictions. However, it is still useful to understand how they see the economy, as their view ultimately drives their actions and shapes equity and bond markets.

The Fed uses the Bureau of Labor Statistics Unemployment Rate (U-3) as its gauge of the strength of the labor market. We prefer the labor force participation rate, as it measures “the percentage of the population that is either working or actively looking for work.”

As we can see, the rate has started to tick back up heading into the end of the year but is still a long way from pre-COVID levels. Note that, as the participation rate climbs, a positive in terms of how the population feels about the job market, it will have a negative impact on the U-3 unemployment rate which measures the number of people out of work and looking for a job, regardless of whether they recently had a job or if they’d been out of work for years and are now looking again.

The Great AI Reckoning?

We believe that 2026 will be the year that we start seeing investors separate AI wheat from the chaff. Even though ChatGPT has only been around since late 2022, AI has become the latest meme trade to dominate the headlines. According to FactSet, the term “AI” was cited on 306 earnings calls by S&P 500 companies during Q3. This number is well above the 5-year average of 136 and the 10-year average of 86.

In fact, this is the highest number of S&P 500 earnings calls on which “AI” has been cited over the past 10 years (using current index constituents). The previous record over the past 10 years was 292, which unsurprisingly occurred in Q2 2025.

At the sector level, the Information Technology sector has the highest number (63) of earnings calls citing “AI” for Q3. The Information Technology (95%) and Communication Services (95%) sectors had the highest percentages of earnings calls citing “AI” in Q3.

FactSet notes that S&P 500 companies that have cited “AI” on Q3 earnings calls have seen a higher average price increase compared to S&P 500 companies that have not cited “AI” on Q3 earnings calls since December 31 (13.9% vs. 5.7%), since June 30 (8.1% vs. 3.9%), and since September 30 (1.0% vs. 0.3%).

Just as the automobile, the internet, and smartphones have been transformative technologies, Artificial Intelligence will be as well. And as with those earlier innovations, leaders will emerge, and also-rans will fall by the wayside, either going out of business or merging to stay in business.

For every GM, there will be a Hudson Motors, which merged with Nash-Kelvinator in 1954 to form the American Motors Corp, later acquired by Chrysler.

For every Amazon, there will be a Pets.com, for every Apple, there will be a Blackberry, and for every Tesla, there will be a Lucid.

We have already seen some of this in Super Micro Computer, Inc. (SMCI), which makes liquid- and air-cooled AI servers for training and inference with integrated graphics processing units (GPUs), such as Nvidia’s. The company competes with familiar names such as Dell, Hewlett-Packard Enterprise, and Western Digital. Still, in 2024, it became an AI meme stock, rising faster than Nvidia in the first half of the year, even though the fundamentals didn’t warrant it.

By the end of the year, it was trading back to its 2023 levels, and anyone who had bought, even at the end of 2024, would have been better off with Dell or Hewlett-Packard, names that would have drawn laughter at many investment conferences that year.

More recently, we saw the same thing happen with Oracle when the stock ran up nearly 100% for the year before quickly reversing.

Oracle has been around for decades and has been a good long-term hold for most of that time, while Super Micro Computer has been around since 1993. Both may end up in one of our strategies in the future, but not at ridiculous valuations based on nothing but traders chasing the “next Nvidia trade.” While we do consider price momentum when screening for stocks, earnings quality and valuation will always trump short-term price movement.

Volatility is here to stay

Algorithmic trading now dominates daily volume on U.S. exchanges like the NYSE. Around 2003, algorithmic trading made up only ~15% of U.S. market volume. By 2010, it surged to over 70% of U.S. equity trading.

This shows a dramatic shift in just a few years as exchanges went electronic and algorithmic strategies proliferated. In 2018, Select USA estimated that algorithmic trading accounted for 60–75% of overall trading volume in the U.S., European, and major Asian markets. And a 2023 Benzinga article reported the same figure — 60–73% of equity trades in the U.S. are algorithmic.

In October 2025, the NYSE reported processing about 1.2 trillion order messages per day — nearly three times the volume seen four years earlier (~350 billion/day during COVID 19). This surge is attributed to AI-driven trading, algorithmic strategies, and hyper-speed market participants, according to NYSE President Lynn Martin. [pymnts.com]

Now, as Warren Buffett noted in the late 1990’s, in the long run, the stock market is a weighing machine, meaning that capital-efficient, market-dominating “heavyweights” will eventually provide superior returns, In the short-term, the markets are a voting machine, and high-speed algorithms based on micro-second headline scans and deal flow analysis will continue to magnify daily moves in both the indices as well as individual stocks. While, in the long run, it shouldn’t impact overall returns, it can still be unnerving to look at holdings and see your Palantir shares down 5% for no apparent reason.

Are Rare Earths Too Big to Fail?

Rare earth elements (REEs) have become the backbone of modern technology, powering everything from smartphones and electric vehicles to advanced defense systems and renewable energy infrastructure. Their strategic importance is undeniable; without them, the advancement of all the technologies we are discussing would stall. This dependency raises the question: Are rare earths too big to fail? In many ways, yes. The concentration of rare earth production in a few countries, particularly China, creates significant geopolitical and economic vulnerabilities. Any disruption in supply could ripple across industries, impacting innovation, national security, and financial stability worldwide.

This implies that governments and corporations will intervene to prevent collapse, and we are already seeing this dynamic play out.

Nations are investing heavily in domestic mining, recycling technologies, and alternative materials to reduce reliance on single-source suppliers. While rare earths themselves are not irreplaceable in the long term, the current lack of viable substitutes and the complexity of scaling new supply chains make them indispensable for the foreseeable future.

In short, rare earths are not just critical; they are foundational to the global economy, and their failure would have consequences far beyond the mining sector. This means rare earths will be treated as a strategic priority by policymakers and industry leaders, with coordinated investment, innovation, and risk mitigation to ensure that the technologies driving our future do not stall.

For us, the strategic importance of rare earths means exposure to this sector can offer long-term growth potential, especially as demand accelerates with the global shift toward electrification to power the data centers needed for our high-technology economy. However, the market is highly volatile and influenced by geopolitical risk, supply chain disruptions, and regulatory changes. As with all investment opportunities, we will approach rare earth investments with caution, diversify holdings, and consider indirect exposure through companies with strong vertical integration or recycling capabilities rather than relying solely on pure-play miners.

Changes coming in 2026

While a few of the provisions of the reconciliation bill signed into law last July have made headlines, such as the no tax on tips and the misnamed no tax on Social Security, very few people realize that it was the equivalent of approximately 30 separate bills, all signed at once.

We’ll be spending the first few weeks of January diving into the new law, so you won’t have to, and we’ll probably publish a separate note once we have a better understanding of the benefits and risks to our clients. Until then, here are some things to incorporate into your 2026 planning:

Retirement Plans

The IRS has announced updated contribution limits for retirement plans for 2026, with the elective deferral limit for 401(k), 403(b), and eligible 457 plans increasing to $24,500, up from $23,500 in 2025. For individuals aged 50 and over, the catch-up contribution limit for these plans rises to $8,000, up from $7,500, bringing the maximum total contribution to $32,500. Workers aged 60 to 63 are eligible for a higher catch-up limit of $11,250, bringing the total contribution to $35,750.

The IRA contribution limit increases to $7,500 for 2026, with a catch-up contribution of $1,100 for those aged 50 and over. Additionally, the phase-out range for deducting traditional IRA contributions for single taxpayers covered by a workplace plan expands to $81,000–$91,000, and for married couples filing jointly, it increases to $129,000–$149,000. The Roth IRA income phase-out range also increases to $153,000–$168,000 for singles and $242,000–$252,000 for married couples filing jointly.

Taxable Accounts

For people pulling from taxable accounts, the Long-Term Capital Gains limits for 2026 have increased from 2025.

This means that a married couple filing jointly can take capital gains of up to $98,900 before they must pay any Federal Income Tax. And, when combined with the new standard deduction, a couple under the age of 65 could earn up to $131,100 of combined income (capital gains plus dividends plus other income), tax-free, and potentially more if both are over 65.

This has significant tax implications, whether you need to sell some of your holdings to pay the bills or if you want to shift some of your gains to fixed income or a more conservative dividend strategy.

New Year Planning

As we have done in the past, we’ll be sending out our annual questionnaires in January. While we must do this to remain in compliance with state regulators, it also helps us when reviewing your individual investment needs and allocations to keep them aligned.

Investment Management clients will receive our Risk Tolerance Questionnaire, while Wealth Oversight clients will receive our Annual Snapshot Questionnaire. Both forms are now delivered securely to your email inbox via DocuSign. If you could take a moment to complete the forms and return them, it will help immensely on our end and make strategy conversations much more meaningful.

As always, it is a pleasure to get to know you and to work with you, and we are grateful for the privilege.