Happy New Year!

 

Closing out 2025, U.S. equity markets delivered another strong year of gains, extending a powerful three-year run despite notable volatility along the way. The S&P 500 rose 17.9% for the year, following advances of 26.3% in 2023 and 25% in 2024. The Nasdaq finished higher by 22.2%, while the Dow Jones Industrial Average gained 14.9%. These returns were achieved in a year that included a sharp intra-year drawdown of nearly 19%, reinforcing the importance of staying disciplined through market swings. Encouragingly, third-quarter GDP surprised to the upside at 4.3%, underscoring continued economic resilience even as financial conditions evolved.
 

Monetary policy remained a central influence throughout the year. In December, the Federal Reserve lowered its federal funds target rate by 25 basis points to a range of 3.50%–3.75%, marking the third rate cut of 2025 and likely the final one before Chair Jerome Powell’s term ends in May. Meeting minutes signaled that policymakers do not anticipate rate cuts in 2026, with the Fed appearing more focused on labor market conditions than on inflation or tariff-related risks. Current market guidance points to a slow and measured path forward, with only one cut projected in both 2026 and 2027.
 

Market leadership evolved meaningfully as the year progressed. While growth stocks dominated earlier in the cycle, 2025 saw periods of rotation and broadening. Healthcare emerged as the strongest sector in the fourth quarter, offering a blend of defensive stability and selective cyclical exposure. More broadly, rate-sensitive, cyclical, and defensive sectors increasingly shared leadership as traditional growth areas such as information technology and communication services periodically paused. By late November and December, much of the market’s strength came from areas outside of AI, reflecting investors’ growing focus on valuation, balance, and earnings durability.
 

Under the surface, market participation modestly improved. The “Magnificent Seven” still comprised roughly one-third of the S&P 500 and accounted for just over 40% of the index’s total return in 2025, but this influence was reduced compared to prior years. For the first time since 2021, these stocks contributed less than half of the market’s total return. Approximately 64% of S&P 500 companies finished the year positive, and about 30% outperformed the index itself. Notably, this year’s gains were driven more by actual earnings growth rather than by rising valuation multiples, signaling healthier market fundamentals than in past cycles dominated by optimism alone.

 

Against this backdrop, the AI theme continued to captivate investors, even as skepticism grew. Questions emerged late in the year regarding whether some technology earnings were being artificially inflated through accounting practices and whether portions of AI’s hypergrowth reflected circular spending among large technology firms. These concerns came into sharp focus following Nvidia’s earnings report on November 19, 2025. The market’s reaction over the subsequent 24 hours captured the defining tension of the AI era—excitement and innovation tempered by caution and fear of excess.

 

Nvidia CEO Jensen Huang pushed back forcefully against bubble narratives, reiterating his view that global annual spending on AI infrastructure could reach $3–4 trillion by 2030. Importantly, Nvidia’s growth in 2025 was not solely driven by hyperscalers, as had been the case earlier in the cycle. Instead, the company announced multiple new partnerships with global enterprises, sovereign clients, and emerging “neo-cloud” providers, highlighting how rapidly and broadly the technology landscape is expanding.

 

Looking ahead to 2026, expectations remain constructive but measured. Per Argus Research, Wall Street forecasts for the S&P 500 range from flat returns to gains as high as 17%, with a median outlook of roughly 10–11%. Historically, January tends to attract new capital, and data suggests that when January posts positive returns, the full year finishes higher approximately 85% of the time. While we are entering the weakest historical phase of the presidential cycle—and pullbacks are always possible—we begin 2026 with stronger fundamentals, clearer Federal Reserve policy, and lower interest rates than a year ago. For these reasons, there is reason for optimism in 2026, even as headline risk and uncertainty remain ever-present. We will continue to monitor developments closely and adjust our outlook as conditions evolve.

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Information used in the preparation of this article was informed by research and materials from First Trust Advisors, Confluence Investment Management, Argus Research, and Zacks Research.