Insights

Quarterly Commentary

4Q 2025

Though few saw it coming, 2025 turned out to be a good year for investors. After a modest advance in the final quarter, US stocks posted 17% gains, far better than the forecasts touted by Wall Street as the year began. But it wasn’t easy - that return was earned by persevering through a shake-out that lasted from February through May.

Even less anticipated were the returns registered elsewhere. Foreign stocks gained about 34% in US dollar terms. They had trailed the US year after year to the point where many frustrated investors gave up hope. Sure – foreign stocks were trading at significant discounts (price to earnings ratios 30 to 40% lower by some measures), but earnings have been growing much faster at the large tech companies that dominate the US stock market. US exceptionalism had become accepted wisdom. What changed?

The simple answer is that world events reminded investors that nothing is forever and that it might not be wise to assume that US stocks will dominate for years to come. Concerns about the dollar and unfavorable trade policies were crystallized in April when President Trump appeared in the Rose Garden and displayed a list of tariffs the US would be charging the rest of the world. A two-day 10% sell-off ensued as shocked investors realized that the US was no longer the protector of the global trading system.

The magnitude of the levies invited comparisons to the Smoot-Hawley tariffs of the 1930’s – generally thought to have deepened and prolonged the Great Depression. Pundits lowered their year-end targets for stock indexes. Hoped-for interest rate cuts were put on hold as the Federal Reserve waited to see how the economy would be impacted. Many central banks elsewhere purchased more gold and fewer US Treasury bonds, pushing the price of the precious metal up 60% in 2025.

Chastened by the negative reaction, Trump paused the tariffs for ninety days, and then proceeded to threaten, impose and retract over the rest of the year. The effective tariff rate today is estimated to be 14%, about half of the posted tariff rate of 28%.

So far, the cost of the tariffs appears to have been shared among consumers, businesses, and foreign producers who adjusted what they are willing to pay or receive for various goods and services. Businesses adapted quickly - US corporate earnings improved a surprising 11% over the course of 2025. Indeed, the US economy demonstrated resilience throughout the year, including the fourth quarter’s congressional standoff that caused a record-long government shutdown.

What we learned (or re-learned) in 2025
When things look terrible, remind yourself that the moment will pass – history rewards optimism. When Trump announced the tariffs, we momentarily lost our minds, like many, before quickly regaining perspective. Given the reaction of markets, we concluded that tariffs at those levels were likely to be rescinded, delayed, or softened. Staying the course paid off yet again.

Risks are always present – it’s the awareness of them that changes. That goes a long way toward explaining the stock market’s ups and downs over the course of twelve months.

Looking Ahead
Wall Street strategists expect current trends will continue and foresee another year of healthy gains. The latest Factset analyst poll projects 15% earnings growth and 15% returns for the S&P 500. Consumer spending is expected to hold up despite nearly 3% inflation. Last year’s tax bill should put more money in consumers’ pockets come April. The average refund is projected to increase by $500 to $1,000 - tax rates were lowered but withholding was not. Businesses also stand to benefit from 100% depreciation and full R&D expense deductions in year one.

The ongoing wave of AI-driven capital investment will continue to be a powerful force, similar to past episodes such as the development of railroads in the mid-19th century and the late-1990s information/telecommunications boom. Massive data center capex, and the related knock-on effects, will likely remain AI’s primary economic impact in 2026. However, significant productivity gains need to manifest sometime soon to deliver on the promise of AI. The Artificial Intelligence story can go either way – and may well do both over the course of 2026.

What might derail the bull case?
The Supreme Court is expected to soon rule on the legality of some of the biggest tariffs. While striking down the tariffs should provide an immediate benefit to businesses hit hardest by the levies, the administration would likely attempt to sidestep unfavorable rulings by invoking other statutes/rules to reinstate the tariffs, leaving the ultimate impact up in the air. Add to this that the USMCA trade agreement between the US, Canada, and Mexico has a mandatory review in 2026, and it’s very likely we have another year of volatile trade headlines.

Federal Reserve Chairman Powell’s term as chair ends in May. Inflation remains above target and the labor market appears to be cooling without breaking. In this environment, the Fed’s default posture is caution. In December the Fed projected one quarter-point cut in 2026, yet bond and stock markets are anticipating two or three cuts. The president is agitating for more. The Justice Department recently announced a criminal investigation regarding building renovation costs that is being interpreted as an attempt to exert control over the Fed and its decisions about interest rates. As much as we would like to see lower interest rates, the Fed’s independence and adherence to process and laws are essential to the integrity of the American financial system.

China’s military recently conducted drills around Taiwan, dispatching ships and planes to simulate a blockade. 90% of the island’s energy relies on fossil fuel imports. 60% of Taiwan’s food is imported. 90% of the world’s advanced computer chips are produced in Taiwan. China is no doubt trying to gauge the willingness of America and its allies to help Taiwan survive a blockade (which seems more likely than a flat-out attack). Possible outcomes range from serious military confrontation to a bloodless occupation to another year of brinkmanship. Amidst the US operation in Venezuela and a possible revolution in Iran, the odds for Chinese aggression seem to be increasing.

Consensus view
A 15% return for US stocks in 2026 would be a most welcome result, especially after the above-average results of the last three years. The stock market's historical average return is between 8 and 10%, depending on the period measured. Yet there have been only six years since the 1950s that the market has registered a return near 10%. The average return is useful for planning over a longer time horizon, but a return outside the 8 to 12% range is a more likely result in any given year.

Over the past eight years, the S&P 500 has returned better than 20% four times and has posted two down years. Strategist predictions have missed the year-end result by an average of 16%! It’s possible that 2026 will resemble 2025 with a 10 to 20% correction followed by a pleasing and unanticipated rally that brings returns up to the predicted 15%. Acknowledging the folly of trying to predict the unpredictable, we will punt.

Strategy
We seek to avoid the comfort of consensus thinking. Excessive enthusiasm for a particular stock or sector is a warning sign, just as pervasive pessimism is an invitation to consider a potentially rewarding opportunity. We try to be in a position to act when the consensus view differs dramatically with our own.

We are increasingly wary of many AI (large US tech) stocks. Their prices assume strong earnings growth in 2026 and beyond, where the crystal ball gets increasingly cloudy. Elsewhere many businesses are positioned to enjoy tailwinds in the coming year – improving pricing power, lower input costs, deregulation, and of course, the benefits of AI adoption. This portends a broadening of stock market returns. We will stick with our diversified strategy that does not rely on outperformance of large tech.

During 2025 we were pleasantly surprised when the share prices of attractively-priced businesses suddenly took off after a few years of moribund performance. We are hoping for more of that in 2026.