The stock market delivered stellar gains in 2025, with the S&P 500, Dow Jones Industrial Average and Nasdaq Composite climbing 16.39%, 12.97% and 20.36% respectively. While mega-cap technology and communications services stocks led the advance, market breadth has improved notably, and the equally weighted averages seem poised to deliver outperformance in the year ahead.
Buoyed by fiscal and monetary stimulus, economic fundamentals are strong as we enter the New Year. While debate remains whether any benefits for lower income households included in the 2025 One Big Beautiful Bill Act (OBBBA) may be diminished by tariffs and revisions to Medicaid and the Supplemental Nutrition Assistance Program, it seems clear that permanently lower tax rates should benefit most taxpayers, while permanent 100% bonus depreciation and immediate R&D expensing will benefit corporate America. The Congressional Budget Office sees OBBBA boosting GDP by 0.9% in 2026. Meanwhile, the Federal Reserve again cut interest rates at its December meeting to a range between 3.5% to 3.75% and launched a new Reserve Management Purchase facility to purchase $40 billion in Treasury bills per month.
With U.S. GDP expected to grow between 2 and 3% in 2026 and inflation moderating but still stubbornly above the Fed’s 2% target, one might ask why the Fed is cutting interest rates and initiating a stealth QE program. While consensus building at the Fed has become more difficult for Chair Powell, the majority of the FOMC see greater risk to the economy from rising unemployment than in price instability. The Fed is positioned to lean on stabilizing the labor market in the coming quarters and odds favor at least one and maybe two additional 25 basis point cuts by the end of 2026.
Unemployment rose to 4.6% in November from 4.4% in October, the highest level in more than four years. After adding over 1.6 million jobs in 2024, the U.S. economy added fewer than 500K jobs in 2025. Because of the inclusion of a statistical model to estimate the number of jobs added from new businesses and lost from shuttered ones, Fed Chair Powell is concerned that the data may be overstating job creation by up to 60,000 jobs a month. If true, this would change the employment picture dramatically and result in about 20,000 jobs lost per month rather than the 40,000 monthly gains reported over the last six months. With immigration dramatically lower under Trump administration policies, Baby Boomers continuing to retire en masse, tariff uncertainty, and widespread adoption of AI and robotics, both supply and demand dynamics for labor offer a murky picture. As unemployment has risen, wage pressure and inflation have eased, giving the Fed additional cover to cut rates.
The Fed’s new Reserve Management Purchase facility is an interesting twist to monetary policy and seems intended to soak up rising supply of Treasury debt and help fund our massive and growing budget deficit. It is estimated by Strategas Research that the Fed’s annual demand for Treasury bills will approximate $240 billion to $300 billion per year, amounting to between 60% and 75% of the Treasury’s issuance of short-term obligations. This in turn will allow the Treasury to increase the ratio of low-interest rate T-bills issued compared to high-interest rate notes and bonds, thereby reducing borrowing costs. This balance sheet manipulation has been likened to “financial repression” and difficult to distinguish from plain old quantitative easing (QE). The adage “don’t fight the Fed” seems particularly true with such favorable monetary stimulus in place.
The twin boost to U.S. manufacturing from the buildout of AI infrastructure and deglobalization/reshoring due to Trump tariff policy should help propel GDP in the year ahead, even if consumer spending proves sluggish in the wake of rising unemployment. Lower interest rates should lead to lower borrowing costs and help stabilize consumer spending. Further, we are optimistic that AI benefits will accelerate beyond the picks and shovel phase and usher in higher productivity throughout Corporate America, in turn leading to higher profit margins, increased earnings, and greater propensity for shareholder reward through dividend growth and buybacks.
Of course, geopolitics is always a wild card. While the recent military action in Venezuela may provide the U.S. with even greater long-term energy security at China’s expense (China purchases nearly two-thirds of Venezuelan supply), it also gives China political grounds to use military force against Taiwan. Perhaps control of Venezuelan oil will give the U.S. additional leverage against the likes of China and Russia.
These mostly positive fundamentals are not lost on the stock market. The S&P 500 trades at a historically high forward PE of 22, leaving the market vulnerable to unpleasant surprises. The Mag 7 mega-cap cohort trades at an even higher forward PE of 28. With Mag 7 stocks representing 35% of the S&P 500 market cap, any precipitous decline in this highly concentrated group will disproportionately impact the overall market. Necessary ingredients are in place for market breadth to continue improving and the equally weighted portfolio to fare well in the year ahead. With PE multiples so high, we expect heightened volatility around quarterly earnings. With consensus S&P 500 earnings expectations at $310 for 2026 and $350 for 2027, the stock market seems fairly, if not fully, valued. Should 2027 earnings expectations prove reasonable, and the markets maintain current PE multiples, we could see the S&P trade up to 7,700 in the year ahead. Money market reserves surpassed $8T for the first time in December, setting investors up to buy the inevitable dips.