The S&P 500 gained 2.7% during the fourth quarter, bringing the index’s total return for 2025 to 17.9% and marking the third consecutive year of double-digit gains for U.S. stocks. Investors had to navigate a 43-day government shutdown beginning on October 1st that resulted in a scarcity of economic data critical for assessing inflation, labor market conditions, and the outlook for interest rates. After a volatile first half of the quarter, markets rebounded in late November, with the S&P 500 hitting record highs by year-end, supported by expectations for lower interest rates alongside strong corporate earnings growth. Still, investors continued to seek diversification abroad, and international markets outperformed U.S. stocks once again in the final months, capping an impressive 2025 for both developed and emerging markets.
Fixed income markets also delivered solid results in 2025, with the Bloomberg U.S. Aggregate Bond Index returning 1.1% during the quarter and finishing the year with a total return of 7.3%. Short-term bond yields fell as the Federal Reserve cut interest rates two more times at its final meetings of the year, bringing the federal funds rate down to 3.50–3.75%. Slowing jobs growth kept the focus on supporting the labor market, while inflation remained steady despite concerns that tariffs could drive prices higher. Looking ahead to 2026, expectations are for one or two additional rate cuts, though Fed members are divided on the path forward with inflation still above the 2% target. The central bank also faces increased political pressure from the Trump administration and the appointment of a new Fed president in May. For now, policymakers are waiting for more evidence on inflation and labor market trends before deciding on their next move.
Market volatility resurfaced during the fourth quarter, driven by renewed trade tensions and growing concerns around corporate spending on artificial intelligence. Throughout 2025, market pullbacks were typically short-lived, as optimism quickly returned and investors stepped in to buy the dip—a pattern that continued into year-end. Expectations for lower interest rates and resilient corporate profit growth across the broader market helped underpin equities, even as pockets of volatility emerged. While enthusiasm for AI remained a key support, the market has become increasingly selective, rewarding companies that demonstrate a clear path to profitability from AI initiatives while questioning those whose potential returns remain uncertain, particularly as elevated valuations leave little margin for disappointment. As we head into 2026, signs of a rotation into the broader market outside of mega-cap technology stocks have begun to emerge, reflecting wider participation across sectors. Whether this trend continues will depend on earnings growth among the AI cohort, as the heightened focus on profitability leaves these names especially sensitive to weaker than expected results.
Investors are optimistic heading into the new year, supported by several tailwinds. Expectations for another year of solid corporate earnings growth, the positive impact of recently enacted tax cuts, and the prospect of gradually lower interest rates continue to reinforce confidence in the outlook for risk assets. Trade-related uncertainty, while still present, is expected to be much less disruptive than it was in 2025. At the same time, a softening labor market, elevated valuations, and concentration in a handful of large technology companies remain key risks. Overall, while challenges persist, supportive economic fundamentals, favorable policy conditions, and signs of broader market participation set a constructive backdrop for 2026.