Investment Management - Fourth Quarter 2025
Surprise, Surprise, Surprise!
Happy New Year! In what was a year full of surprises, markets defied expectations in 2025, with broad rallies in stocks and bonds driven by strong U.S. economic growth, artificial intelligence (AI) enthusiasm, and resilience to geopolitical and policy shocks. Recession fears, weak consumer confidence, shifting alliances, rising tensions, and the longest government shutdown in U.S. history all failed to derail the bull market. As we close this exceptional year and look toward 2026, the key question shifts from whether surprises will continue to whether investors are adequately prepared for them.
Key Takeaways from the Fourth Quarter
• Equity markets declined in the final few trading sessions, but the S&P 500 index finished 2025 with a gain of nearly 18%, the third straight year of double-digit returns.
• International markets outperformed domestic markets by the widest margin in 20 years, due to currency fluctuations, improved earnings growth, and attractive valuations.
• Concerns of an "AI bubble" persisted throughout the year due to massive infrastructure investments, market concentration, and elevated valuations. However, the technology is already driving measurable productivity gains and revenue growth, suggesting these bubble concerns may be premature.
• The Federal Reserve cut interest rates for the third consecutive time to the lowest level in three years. Fed Chairman Powell suggested they have now reached the level of rates low enough to counter any risk to employment while still fighting inflation.i
Shazam! What a Quarter and Year it Was!
The fourth quarter capped a remarkable year for U.S. equities, with the S&P 500 advancing 2.66% in the final three months and just under 18% for all of 2025. This marks a third consecutive year of double-digit returns, following gains of 26% in 2023 and 25% in 2024, only the twelfth such streak in the past century. International equity markets delivered even stronger returns, with the MSCI EAFE Index climbing almost 5% in the fourth quarter and over 31% for the full year. This reversal ended a prolonged period of domestic dominance, marking the first time since 2006 that developed international markets outperformed the S&P 500 by double digits.
Performanceii for various indices for the three-month (not annualized), one-year, three-year, and five-year periods appears below:
Bond Indices
Dates | ICE BofA 1-5 Yr. | ICE BofA 1-10 Yr. | ICE BofA 1-12 Yr. Muni |
|---|---|---|---|
9/30/25 - 12/31/25 | 1.22% | 1.22% | 0.94% |
12/31/24 - 12/31/25 | 6.80% | 7.89% | 5.04% |
12/31/22 - 12/31/25 | 6.07% | 6.59% | 3.62% |
12/31/20 - 12/31/25 | 2.23% | 1.64% | 1.25% |
Equity Indices
Dates | Dow Jones Ind. Avg. | NASDAQ Composite | S&P 500 (Large) | S&P 400 (Medium) | S&P 600 (Small) | MSCI EAFE (Int'l) |
|---|---|---|---|---|---|---|
9/30/25 - 12/31/25 | 4.03% | 2.72% | 2.66% | 1.64% | 1.70% | 4.86% |
12/31/24 - 12/31/25 | 14.92% | 21.14% | 17.88% | 7.50% | 6.02% | 31.22% |
12/31/22 - 12/31/25 | 15.36% | 31.43% | 23.01% | 12.56% | 10.17% | 17.22% |
12/31/20 - 12/31/25 | 11.58% | 13.35% | 14.42% | 9.12% | 7.31% | 8.92% |
Well, I’ll Be! Washington's at it Again!
The 43-day federal government shutdown from October 1st to November 12th was the longest in U.S. history. Markets were largely unfazed, with the S&P 500 rising 2.4% during the impasse.iii While the long-term economic impact should be negligible, the Congressional Budget Office estimated the shutdown reduced fourth quarter gross domestic product (GDP) growth by 1-2 percentage points.iv More significantly, the collection of economic data was disrupted, with October inflation and employment figures missing entirely. This data blackout complicated the Federal Reserve's policy decisions and market participants' ability to assess economic conditions.
The Trump administration's tariff program, implemented via the International Emergency Economic Powers Act (IEEPA), maintained effective tariff rates of 14% as of November, the highest since World War II.v Legal challenges have gained traction as multiple federal courts ruled against certain IEEPA tariffs, though appeals have kept them temporarily in effect. While the surge in prices many economists predicted earlier in the year has not materialized, policy uncertainties continue to weigh on business confidence and contribute to market volatility.
Golly, Those Numbers Sure are Something!
Economic data, when available, painted a picture of continued resilience. The first estimate of third quarter GDP came in at 4.3% annualized, well above the 3.3% consensus and marking the fastest quarterly growth in two years.vi Consumer spending remained robust while business investment surged on AI-related infrastructure spending. As of December 23rd, the Atlanta Fed's GDPNow forecast projected fourth quarter growth of 3.0%, supported by continued AI investment and resilient consumer fundamentals.vii
As noted previously, the government shutdown severely impaired economic data visibility. The Bureau of Labor Statistics was unable to collect October employment or inflation data, creating gaps in understanding labor market dynamics at a critical juncture. When data collection resumed in mid-November, analysts faced difficulty distinguishing between genuine economic trends and statistical distortions caused by the shutdown.
While the unemployment rate has risen from 4.2% to 4.6% over the past year,viii with reduced hiring in many sectors and reduced entry-level roles due to automation, the increase partly reflects more Americans re-entering the labor force and actively seeking work. As the economy adapts to AI integration, workers are finding roles that complement rather than compete with automated systems, suggesting an adjustment period leading to new forms of employment as industries reshape.
What's Sergeant Carter – I Mean, Chairman Powell – Saying?
The Federal Reserve cut rates by 25 basis points at both the October 29th and December 10th meetings, bringing the federal funds rate to 3.50 – 3.75%. The December meeting revealed significant dissention within the FOMC, with two members favoring no cut and one preferring a 50 basis point reduction, the first 9-3 vote since 2019. Chairman Jerome Powell described it as a "close call" and stated the Committee is “well-positioned to wait and see how the economy evolves from here.”ix
The Fed's updated Summary of Economic Projections signals just one additional 25 basis point cut expected in 2026, down from earlier projections of multiple cuts. This hawkish shift reflects persistent inflation concerns, with their preferred measure of inflation expected to end 2025 at 2.8% and decline only gradually to 2.5% by the end of 2026.x
Chairman Powell's term expires in May 2026, with President Trump expected to name his successor early in the new year. Candidates include National Economic Council Director Kevin Hassett, former Fed Governor Kevin Warsh, and current Fed Governor Christopher Waller. While questions around Fed independence have intensified amid White House pressure for lower rates, the Fed proactively reappointed 11 of 12 regional bank presidents in December, a move widely interpreted as protecting against potential political interference through 2031.
Well, Shut My Mouth! Companies are Doing Just Fine
According to FactSet, S&P 500 companies are projected to report fourth quarter earnings growth of 8.3%, which would mark the tenth consecutive quarter of year-over-year earnings growth.xi Analysts expect continued strength in 2026, with earnings estimated to rise 15% for the full year, which would be a third straight year of double-digit growth.xii
The AI theme remained central to market performance, with related capital expenditures accounting for an estimated 37% of real GDP expansion in 2025.xiii However, questions about an "AI bubble" intensified in the quarter as valuations of certain companies reached levels comparable to the late 1990s tech boom. We see key differences from that era, including how AI investments are financed and how quickly new infrastructure is deployed, and believe concerns about a bubble bursting are likely premature.
Market concentration remained elevated, but breadth improved. The "Magnificent Seven" technology stocks comprise approximately 35% of S&P 500 market capitalization, but meaningful rotation into other sectors occurred in the second half. Sectors gaining traction included Industrials (benefiting from reshoring and infrastructure spending), Financials (aided by steeper yield curves), and Health Care (rebounding on demand and attractive valuations).
How We're Marching Forward
Throughout the quarter and full year, our portfolio positioning balanced confidence in the bull market's continuation with prudence given elevated valuations. We maintained diversified exposure across market capitalizations and sectors while remaining mindful of the historically rare streak of double-digit returns.
As mentioned in previous letters, we have made a concerted effort over the past two years to shift taxable accounts from actively managed mutual funds to more tax-efficient exchange-traded funds (ETFs). Our year-end tracking of estimated mutual fund capital gain distributions shows significant progress, as a smaller portion of overall capital gains now comes from mutual fund distributions. We also harvested tax losses where appropriate, though given three years of market strength, such opportunities were limited.
What's Around the Corner, Sarge?
As we enter 2026, we maintain a constructive but cautious outlook. The economic backdrop remains supportive, with solid growth, moderating inflation, and continued corporate earnings expansion. However, several considerations warrant attention.
Valuation discipline becomes increasingly important. After three years of exceptional returns, the S&P 500's forward price-to-earnings (P/E) ratio of 22X is elevated compared to its 30-year average of 17X.xiv While not necessarily predictive of near-term corrections, lofty valuations leave limited margin for disappointment.
Fed policy transition and leadership change create uncertainty. With Powell's likely departure in May and only one rate cut projected for 2026, the easing cycle may be nearing its end. The incoming Fed Chair will face the delicate balance of maintaining price stability while supporting employment, potentially under greater political pressure than any Fed leader in decades.
Trade and fiscal policy remain wildcard factors. Ongoing tariff negotiations, potential legal challenges, and the economic impact of elevated import duties bear close monitoring. Additionally, while fiscal stimulus has supported growth, the long-term implications of expanded deficits and rising interest costs on federal debt warrant consideration. With the next federal funding deadline set for January 30th, markets may face heightened volatility as Congress navigates budget negotiations and the potential for another shutdown standoff.
The AI investment cycle enters a critical phase where monetization must validate substantial capital expenditures. With companies like OpenAI projected to burn through billions of dollars before achieving profitability, market patience may be tested if tangible returns fail to materialize. However, the productivity gains already evident across industries suggest the technology's transformative potential remains substantial.
We're particularly focused on market breadth as an indicator, as the rotation into previously lagging sectors is healthy and encouraging. Sustained breadth improvement would suggest the bull market is maturing on stronger foundations rather than narrowing dangerously as in the late 1990s. History suggests that after three consecutive years of double-digit returns, the fourth year typically delivers more modest gains. However, the current bull market's strength and breadth of corporate earnings growth may support continued above-average performance.
We remain committed to long-term investment discipline while adapting tactically to evolving conditions. After an extraordinary three-year period, tempering return expectations while staying invested in quality companies positioned for durable growth remains prudent for 2026 and beyond.
Updates from our Outfit
We are happy to introduce two new additions to our team in October. Jace Chambers joined West Financial as our administrative assistant/receptionist, bringing her friendly personality and expertise in the cultural and social science sectors. Previously, she worked with Opera Lafayette in D.C. as their education and community engagement manager. Christian Cormier joined West Financial as an information systems administrator focusing on process optimization and automation. Before joining West Financial, Christian worked for a firm building enterprise resource planning software. He is a certified Salesforce administrator.
Congratulations to Tanya Carson, Matt Cohen, Patrick Fitzgerald, Brian Horan, Abigail Just, Kirstie Martinez, Laura Nash, Jonathan Stolz, and Dan Trosch for being named as Five Star Wealth Managers by Five Star Professional in November 2025.xv
Also in November, West Financial Services was named as one of the Best RIAs to Work For in 2025 by Financial Planning magazine.xvi As always, our commitment to excellent service extends to not only our clients, but also our employees!
We have provided performance figures for the quarter, one-year, three-year, and five-year periods, where appropriate. The custodian where your account is held will be sending Form 1099-DIV (dividends) and Form 1099-INT (interest) information to you directly. Also, Form 1099-B will provide a record of realized gains and/or losses in taxable account(s) as well as any management fees paid directly from your brokerage account(s). Please contact us if you have questions or need additional information for the preparation of your tax returns.
In addition to your statements, your packet will include any restrictions that you have placed on your account. Please review these and contact us should there be any changes. Also, now would be a good time to review your asset allocation and risk tolerance. If there have been any changes to your income, marital status, state of residence, tax bracket, or other information, please be sure to let us know.
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i https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20251210.pdf
ii Each of the S&P 500 Index, the S&P 400 Index, the S&P 600 Index, the MSCI EAFE Index, the ICE BofA 1-5 Year Index, the ICE BofA 1-10 Year Index, the ICE BofA 1-12 Year Municipal Bond Index, the Dow Jones Industrial Average, and the NASDAQ Composite (each, an “Index”) is an unmanaged index of securities that is used as a general measure of market performance. The performance of an Index is not reflective of the performance of any specific investment. Each Index comparison is provided for informational purposes only and should not be used as the basis for making an investment decision. Further, the performance of your account and each Index may not be comparable. There may be significant differences between the characteristics of your account and each Index, including, but not limited to, risk profile, liquidity, volatility and asset comparison. The performance shown for each Index reflects no adjustment for client additions or withdrawals, and no deduction for fees or expenses. Accordingly, comparisons against the Index may be of limited use. Investments cannot be made directly into an Index.
iv https://www.cbo.gov/publication/61823
vii https://www.atlantafed.org/cqer/research/gdpnow
viii https://www.bls.gov/opub/ted/2025/unemployment-rate-4-6-percent-in-november-2025.htm
x https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20251210.pdf
xii https://insight.factset.com/sp-500-cy-2026-earnings-preview-analysts-expect-earnings-growth-of-15
xiii https://www.barrons.com/articles/us-gdp-economy-growth-ai-investment-82e7bf9b
xivJPMorgan Guide to Markets as of 12/31/25.
xv Five Star Wealth Manager Award program, managed by Five Star Professional (FSP), conducts market-specific research throughout the U.S. and Canada to select reputable, specialized, and honest service professionals. This award is for the time period 1/15/25 through 8/1/25. Award candidates that satisfied 10 objective criteria were named 2025 Five Star Wealth Managers. Required Eligibility Criteria: 1. Credentialed as a registered investment adviser (RIA) or a registered investment adviser representative; 2. Actively licensed as a RIA or as a principal of a registered investment adviser firm for a minimum of 5 years; 3. Favorable regulatory and complaint history review; 4. Fulfilled their firm review based on internal standards; 5. Accepting new clients. Additional Evaluation Criteria: 1. One-year client retention rate; 2. Five-year client retention rate; 3. Non-institutional discretionary and/or non-discretionary client assets administered; 4. Number of client households served; and 5. Education and professional designations. Neither WFS nor any of its employees paid FSP a fee to be considered or placed on the final list of Five Star Wealth Managers.
xvi In order for firms to be recognized as Best RIAs to Work For by Financial Planning magazine, Financial Planning magazine and Best Companies Group invite firms to complete a survey, which asks firms to explain their various offerings and practices. Any firm recognized must satisfy the following criteria: 1. Be registered as an investment adviser with the SEC; 2. Have a facility in the United States; 3. Have a minimum of ten employees working in the United States; and 4. Be in business for a minimum of one year. Financing Planning magazine then evaluates each nominated firm’s workplace policies, practices, philosophy, systems and demographics. Additionally, employees are invited to complete a survey to measure the employee experience at the firm. Once both portions of the assessment are complete, the combined scores determine the final ranking and whether the firm will be named one of the Best RIAs to Work For. Firms do not pay a fee to be considered or placed on the final list of Best RIAs to Work For. The only cost is to allow participating firms to view the employee feedback reports.
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