Market Perspectives – Fourth Quarter, 2025

Market Perspectives - Fourth Quarter, 2025

Financial markets were strong globally in 2025 with equity markets achieving double-digit gains both in the U.S. and abroad. The U.S. bond market also had solid returns as the Federal Reserve lowered interest rates several times in the second half of the year.

Equity Markets

The S&P 500 rose to a new all-time high near the end of the fourth quarter. Stocks benefitted from solid earnings growth in the second half of the year and expanding margins. The S&P 500 Index gained 2.7% in the fourth quarter and finished the year up 17.9%.

Technology companies continued to lead the market as the communication services (up 33.6%) and technology (up 24.0%) sectors were the best-performing sectors during 2025. The only other sector that outperformed the S&P 500 was the industrial sector with a 19.3% gain. However, unlike last year, the market's performance was not dominated by the largest technology companies. Of the "Magnificent 7" tech companies, only two outperformed the S&P 500 (Google & Nvidia). Participation broadened as many companies benefitted from the growing trend in Artificial Intelligence spending. AI infrastructure spending is expected to exceed $500 billion in 2026. The NASDAQ Composite Index gained 2.7% during the quarter and was up 22.4% in 2025.

For the fourth quarter, mid-cap stocks, as measured by the Russell Mid-Cap ETF, gained 0.1% and small-cap stocks, as measured by the Russell 2000 Small-Cap ETF, gained 2.1%. Those ETFs were up 10.4% and 12.7% respectively, for the year. Small-cap stocks marked a new high in December, a sign that there was broad participation across sectors within the market.

International equities made gains as well in the fourth quarter after outperforming domestic equities earlier in the year. International Developed markets, as measured by the EFA ETF, gained 4.7% during the quarter, and finished the year up 31.6%. Emerging markets, as measured by the EEM ETF, rose 3.9% in the quarter and were up 34.0% for the year. International equities have benefited this year from a sharp decline in the value of the U.S. dollar. Globally, the MSCI World Index gained 3.3% during the quarter and 22.4% for the year.

Interest Rates

The Federal Reserve delivered two additional rate cuts in the fourth quarter, dropping the Fed Funds rate to 3.75%. The Fed was on hold for nine months, cautiously assessing the impact of tariffs on the economy. A weaker labor market in the latter half of the year, had the Fed resume its easing cycle. The market expects further cuts in 2026, but not until later in the year after Chair Powell's term ends in May. President Trump is expected to announce a new Fed Chairman this quarter.

The projected path of interest rates will remain uncertain until a new Fed Chair is announced. Recent Fed meetings have shown a higher level of dissenting votes among Fed governors and the recent data vacuum caused by the government shutdown left the Fed flying partially blind. Most data series will be caught up by the middle of February, and the next Fed Chair is expected to be in favor of lower rates.

The Bloomberg Aggregate Index, a broad measure of the U.S. bond market, gained 7.3% in 2025, the best year for bond investors since 2020. Investment grade corporate spreads were relatively calm in the second half of the year and the yield curve continued to steepen as short-term rates came down. With ten-year treasury bond yields staying above four percent, the outlook for fixed income investors remains good

The Economy

U.S. GDP growth in the third quarter rose at a 4.3% annualized rate, and the fourth quarter is expected to show roughly 3% growth. The second half of 2025 was clearly stronger than the first half of the year, primarily due to dissipating tariff disruptions. Throughout the past year, monetary policy remained restrictive, interest rates did not collapse as many had predicted, and the economy proved to be far more resilient than most people expected. The economic measures of the most importance in the near term will focus on the labor market and inflation. The labor market appears to be softening, but the government shutdown, falling federal employment, and a complete reversal in immigration policy over the past year have increased the volatility of labor market measures.

In the case of inflation, Core PCE rose over the course of the year and remains above the Fed's goal of 2.0%. Fortunately, the most recent data on inflation has generally come in below expectations, although there is a concern that some of the inputs to the data may not be complete due to the government shutdown last Fall. A private company called Truflation has gained attention recently by providing real-time, independent economic data. Its daily inflation measure is an alternative to U.S., CPI and aggregates data from over 60 providers. Recently, this measure has fallen below 2.0% for the first time in several years.

In addition, falling rental rates, which influence the "Owner's Equivalent Rent" component of CPI, should also put downward pressure on inflation measures in the early part of 2026. This would be a positive development for consumers and give the Fed some latitude in lowering interest rates further.

The economy is benefiting from significant investment in AI infrastructure and prioritizing the reshoring of critical industries. Foreign investment has also increased in the U.S. with estimated spending plans increasing by $1.4 trillion last year, a significant leap from previous years. Despite the recent disruptions to the labor market, we expect economic growth to remain strong in the coming year.

The Quarter Ahead

Strong economic growth, combined with the stimulative effects of the tax bill that is now in force, should lead to some solid economic measures in the first half of the year. Lower oil and gas prices this winter are a bonus that should benefit the consumer who is struggling with higher prices. U.S. corporations are seeing broad-based growth in revenues and earnings as we enter 2026.

S&P 500 revenue growth is estimated to be 7.2% in 2026, which is well above the trailing ten-year average revenue growth rate of 5.3% according to FactSet Research. Ten of the eleven S&P 500 sectors are expected to grow revenues, and all eleven sectors are expected to grow earnings on a year-over-year basis. Current estimates call for the S&P 500 to grow earnings 15% for the year, up from 12.3% in 2025. This would mark the third consecutive year of double-digit earnings growth. A good economy will support future earnings growth and 2026 has tailwinds from incentives in the recent tax bill, Fed rate cuts, and more deregulatory actions from the current Administration.

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Content provided by: R. Daniel Banis, Executive Vice President, Head of CitizensTrust, and Donald Evenson, Senior Vice President, Chief Investment Officer.

CitizensTrust is a division of Citizens Business Bank, N.A. Trust and Wealth Management are provided by CitizensTrust Wealth Management. The information provided is an opinion on economic outlook and not investment advice. The information is not offered with a product or service. This information is not intended to be a substitute for specific tax, legal, or investment planning advice. We suggest that you discuss your specific questions with your qualified tax, legal or investment advisor.