The final quarter of 2025 saw the continued appreciation of the equity markets, but we saw a broadening in that participation, as small cap, mid cap and large caps beyond the Magnificent 7 also contributed to the returns for the quarter.
| Index | Q4 2025 | Year-to-date |
|---|---|---|
| S&P 500 (Large Cap) – Market Weight | +2.7% | +17.9% |
| S&P 500 (Large Cap) – Equal Weight | +1.4% | +11.4% |
| S&P 400 (Mid Cap) | +1.6% | +7.5% |
| S&P 600 (Small Cap) | +1.7% | +6.0% |
In fixed income, the yield curve steepened again last quarter as 3-month T-bill rates dropped 0.35% to 3.67% while 30-year T-bond yields rose 0.11% to 4.84%. Versus a year ago, the 30-year bond yield is just 0.06% higher while all other maturities saw rate declines, with the 3-month T-bill yield down 0.70% and the benchmark 10-Year Treasury yield down 0.40%.
Economic Overview
Economic developments during the fourth quarter were, on the surface, uneventful, partly because whatever developments were occurring were not being reported during what became the longest federal government shutdown in US history, lasting 43 days. With the subsequent release of data, we find that many of the themes of the prior quarter remained relevant.
For instance, the labor picture remained tepid at best. Even factoring in the cuts in the federal work force, monthly jobs growth came in well below the 100,000 mark and the unemployment rate ticked up to 4.5% in November, its highest level since 2021. It inched back down to 4.4% in December, primarily due to a decline in the workforce participation rate. This weakness led the Federal Reserve to cut its target for the Federal Funds Rate – the overnight rate banks charge each other – twice, by 0.25% each time.
Meanwhile, inflation readings showed price increases stubbornly above the Federal Reserve’s long-term target of 2%. At both the consumer and producer levels, the latest year-over-year figures were 2.7%. Combined with poor market reception of the recent rate cuts and the likely near-term expansion of the federal deficit (and thus bond issuance), the Fed signaled that it is shifting to a “wait and see” approach, indicating a slowdown or a potential pause in rate cuts for the first half of 2026.
Despite the backdrop of a weak labor market, economic growth remained robust as third quarter GDP growth came in at a higher-than-expected +4.3% growth rate. It is estimated that significant investment into the build out of the artificial intelligence (AI) infrastructure contributed 1.1% to 1.4%, or a little more than a quarter of the overall economic expansion. Current estimates for fourth quarter GDP expansion of 2.7% suggest a slow-down in growth, partially driven by the government shutdown. Expectations for the first quarter of 2026 also suggest moderate growth, with some tailwinds from the tax refunds hitting households in the first half of 2026 from the One Big Beautiful Bill Act (OBBBA).
As we look forward, there are potentially disruptive events, such as geopolitical instability, highlighted by recent events in Venezuela and rising political unrest in Iran. There is also the fear of collapse of speculative asset bubbles. In prior correspondence, we have discussed the US stock market’s concentration in the Magnificent 7 technology-oriented companies. Another area is cryptocurrencies which have experienced a meteoric rise, in particular over the last 5 years.
Crypto is favored by the current administration and has become a large global financial asset class in itself. However, in the fourth quarter, the sector experienced heightened volatility, as the price of bitcoin dropped 24%, raising the prospects of potential contagion effects as many retail cryptocurrency purchases are highly leveraged. While there were some short periods of high correlations between cryptocurrency prices and tech stocks, the overall impact on equity markets was modest. The cryptocurrency market is proportionately still relatively small at about 0.5% of global financial assets. Here you can see current approximate valuations:
| Financial Asset Class | Estimated Market Value |
|---|---|
| Global Fixed Income | $335 Trillion |
| Global Equities | $132 Trillion (the Magnificent 7 are about $22 trillion) |
| Cash & Deposits | $88 Trillion |
| Gold/Precious Metals | $30 Trillion |
| Private Equity/Debt | $18 Trillion |
| Other Financial Assets | $4 Trillion |
| Cryptocurrencies | $3 Trillion (Bitcoin is ~60% of all cryptocurrencies) |
| Total | $610 Trillion |
Source: McKinsey Global Institute.
Highlighting other events that could impact the economy and markets this upcoming year, the current Chairman of the Federal Reserve, Jerome Powell, will see his term end in May. President Trump has already stated his desire not to reappoint Powell, and just this morning the Justice Department launched a questionable criminal investigation into Powell’s testimony about the Federal Reserve’s renovation of its headquarters. Expectations are that the President will nominate a dovish replacement, someone more likely to lower rates regardless of circumstances. This could help spur economic activity, but it could also backfire.
Interestingly, when the Fed cut the short-term rate it controls this past quarter, rates on long-term bonds determined by market participants rose – both times. In addition to inflation concerns, a ballooning deficit can be problematic for bond investors. Treasury auctions of massively increasing sizes might become difficult to digest, causing lower bond prices and higher rates. These higher rates would then cause even higher deficits, generating a spiral of higher rates and higher deficits. The higher intermediate and long-term rates could stifle economic growth the lower short-term rates were intended to spur. At this point, this is all hypothetical; but possible.
Markets
Still, 2025 was a very good year, marking a third consecutive year of double-digit gains in large-cap stocks and solid returns among small- and mid-caps. Meanwhile, driven by Fed rate cuts, a ballooning deficit, and tariff related uncertainties, the dollar fell 9.5% against the other major currencies, boosting returns for U.S. investors holding foreign assets. The MSCI ACWI ex USA, an index tracking large- and mid-cap stock markets outside the U.S., gained 25.8%. Dollar weakness and inflation concerns also propelled gold and silver, up 65% and 144% respectively. Notwithstanding the geopolitical concerns cited earlier, nothing obvious on the business front stands in the way of continued strength in 2026. But that observation offers limited comfort. Markets do not decline for obvious reasons. They decline for reasons few anticipate. One of our roles is to manage risk and optimize returns within that discipline.
Current valuations for the largest companies are high, but defensible, though not uniformly so. Some, like Nvidia and Google, trade at multiples that align with their growth rates and competitive positions. Others, like Apple, command premiums that reflect brand strength and index-driven buying pressure more than earnings momentum. We hold meaningful positions in names we find attractive while respecting the lessons of history. Market leaders do not stay on top forever. Cisco and General Electric once dominated the index, then collapsed when earnings faltered and multiples contracted simultaneously. That said, we view AI demand as more durable than the trends that lifted those earlier champions, but we size positions accordingly and watch closely.
While we track valuation and competitive dynamics, we also monitor broader threats. At a recent meeting with the President of the Federal Reserve Bank of New York, Tom heard him identify cyber-attacks on financial infrastructure as his primary current concern. We are also mindful of cryptocurrency activity, as a collapse in this realm could trigger forced stock sales as leveraged traders scramble to meet margin calls. Neither risk existed a generation ago.
At present, we are focusing some extra attention on three sectors. In health care, artificial intelligence is compressing drug discovery timelines and improving diagnostic precision, while progress against cancer and other diseases continues to accelerate. In utilities, we note that AI data centers now consume roughly 4% of U.S. electricity, a share that is growing rapidly. Rising utility bills may become a political issue in the midterm elections, and legislators could push data center operators to bear more of the cost or build dedicated power generation. Meanwhile, we expect bifurcation in the consumer discretionary arena, as spending growth is at present concentrated among higher-income households while middle-income consumers carry elevated debt burdens. We favor companies with pricing power sufficient to defend margins in a more challenging environment.
In fixed income, sticky inflation and growing deficits continue to support an emphasis on short-term securities. The lack of extra yield on non-government debt and our desire to maintain excellent liquidity have guided us to steer much into T-bills. At the same time, recent volatility in equities plus an uptick in bankruptcies has impacted many closed-end bond funds (CEFs). CEFs are similar to exchange-traded funds (ETFs) in that they hold diversified portfolios and trade on exchanges. They differ in that closed-end funds do not issue new shares nor do they buy shares back, rendering inefficiencies between their trading levels and the value of their portfolios. We have successfully augmented fixed income returns using CEFs in desired sectors in the past, largely through buying when at deep discounts. With yields in the 10% range due to recent drop-offs, we are tactically enhancing returns, albeit with a smidge extra volatility, in proportions appropriate for pertinent accounts.
One Big Beautiful Bill Act – OBBBA
Congress passed the One Big Beautiful Bill Act in 2025. Many of its provisions will increase the federal deficit, as discussed earlier. We thought it helpful to highlight some aspects related to personal finance.
Most critically, the temporary tax cuts passed back in 2017 were made permanent. In addition to keeping rates lower in general, uncertainty with regard to estates was eliminated. The estate and gift tax exemption was scheduled to be cut in half to about $7 million at the end of 2025, but via the OBBBA it rose to $15 million, with inflation adjustments set to keep it moving upward.
For those in high tax states like New Jersey, a major change is the ability to deduct up to $40,000 in state and local taxes (SALT), up from only $10,000. This benefit phases out as income levels rise from $500,000 and $600,000, and in 2030 the limit goes back to $10,000.
For non-itemizers, a new benefit is the ability to deduct up to $1,000 ($2,000 for a couple) of cash contributions. Itemizers, especially large contributors, have reduced deductibility. However, direct giving out of IRAs was unaffected.
For seniors, there is a new deduction of $6,000 per person, with an income-based phase-out.
For 529 account owners there is an expanded list of qualified expenses such as K-12 supplies and post-secondary training programs.
Beautiful or not, it was big. If you have any questions on any aspect, please feel free to contact us. More broadly, if you or any family members or friends have any questions or potentially need counsel on any financial matter, we are always available to you and them.