January Investment Comments
The Year in Review: Resilience Amidst Fog
The financial markets demonstrated remarkable resilience in 2025, climbing a wall of worry constructed of tariff shocks, geopolitical tensions, and a historic government shutdown. While the S&P 500 index touched record highs in December, investors appear poised to enter January with caution rather than the euphoria often associated with such strong gains. Ironically, this sentiment may bode well for stock returns in 2026.
While the indices are near their peaks, the narrative driving them has become more complex. The soft landing that seemed elusive earlier in the year has arguably been achieved, but it has been accompanied by a data fog caused by the 43-day government shutdown that ended in November, leaving investors and policymakers to navigate with limited visibility.
On December 10, the Federal Open Market Committee (FOMC) voted to lower the federal funds rate by 25 basis points to a range of 3.50% – 3.75%, marking its third consecutive cut. However, the decision was far from unanimous. Governors Jeffrey Schmid and Austan Goolsbee voted to hold rates steady, citing sticky inflation and financial stability concerns, while Governor Stephen Miran pushed for a more aggressive 50 basis point cut to support the labor market. The Fed is attempting to balance a cooling labor market against inflation that remains stubbornly above its 2% target, all while flying partially blind due to the delayed release of key economic reports like the Consumer Price Index (CPI).
The AI Trade: A Reality Check?
Throughout 2025, Artificial Intelligence has been the engine of market performance. The Magnificent Seven and a broader basket of AI-linked stocks have accounted for a disproportionate share of the S&P 500’s gains. However, December brought a sobering reminder that even the most transformative technologies are subject to the laws of financial gravity.
On December 11, shares of Oracle Corporation plunged approximately 11% following an earnings report that missed revenue expectations and, perhaps more importantly, highlighted the immense capital expenditures required to build out AI infrastructure. Oracle has been subject to greater scrutiny given its reliance on debt to help fund its investments, and the company’s struggles sent a ripple of anxiety through the tech sector, reigniting the debate over return on investment for the hundreds of billions of dollars being poured into data centers and chips.
This anxiety was compounded when Broadcom released its own earnings report. Despite posting impressive AI revenue growth of 74%, Broadcom shares fell over 10%. Investors looked past the top-line growth and focused instead on management’s warning that the shift toward lower-margin AI hardware is weighing on overall profitability. The market is also scrutinizing the circular nature of the AI economy, where tech giants invest in startups that use the capital to purchase cloud services from the same giants.
While companies like Nvidia continue to post robust profits, justifying their valuations with tangible cash flows, the Oracle and Broadcom sell-offs serve as a warning. Investors are no longer satisfied with promises of future growth; they are demanding evidence that the massive infrastructure buildout will yield profitable applications in the near term. This scrutiny is healthy. It separates the true innovators from the speculative excesses. Unlike the dot-com bubble of 1999, where companies with no revenue commanded astronomical valuations, today’s AI leaders are generally highly profitable. However, with the S&P 500 trading at a forward price-to-earnings (P/E) ratio of over 22x, above its 10-year average of 18.3x, the margin for error is slim and valuation discipline remains paramount.
Fixed Income and the Yield Curve
While the equity market navigated sharp mood swings, the bond market spent 2025 finding its footing. We would argue that the story of the 10-year U.S. Treasury note this year was not one of volatility, but of a gradual, orderly search for a new equilibrium. After entering the year yielding about 4.6%, yields on the 10-year note drifted lower, briefly testing levels below 4% before settling near 4.2% in December. This tighter range provided a welcome counterweight to the noise in other asset classes.
The most significant development, however, was the restoration of a healthy shape to the yield curve. For the first time in two years, the persistent inversion, where short-term rates are higher than long-term rates, has normalized. As the Federal Reserve aggressively cut short-term rates to support the labor market, long-term yields modestly rose. This divergence is rational. The longer end of the bond market anticipates rising long-term growth and inflation expectations. It is less affected by the Federal Reserve’s short-term interest rate policy.
For investors, this normalization brings a return of more traditional portfolio mechanics. We are no longer in a world where cash yields more than bonds. Instead, bond investors are finally being compensated more for lending money over longer periods. With yields on high-quality corporate and municipal bonds remaining attractive relative to inflation, it makes sense to ladder a bond portfolio, with maturities spread across time. This allows the investor to play the long end of the yield curve today while retaining the flexibility to reinvest as the economic landscape evolves.
Looking Ahead to 2026
As we turn the page to 2026, the consensus expectation is for continued growth. Analysts are projecting S&P 500 earnings growth of 13-14% for the coming year. If realized, this double-digit growth would go a long way toward justifying current valuations. However, risks abound. The geopolitical landscape remains fraught, with conflicts in the Middle East and Eastern Europe continuing to simmer. Domestically, the outlook depends on three moving parts: fiscal spending, tariffs, and Fed policy. These are the critical wildcards that will determine if the economy can grow without reigniting inflation.
Conclusion
As we navigate the complexities of 2026, from the AI capex cycle to the shifting interest rate environment, our philosophy remains unchanged. We do not attempt to time the market or predict the unpredictable. Instead, we focus on owning high-quality companies with durable competitive advantages, strong balance sheets, and the ability to generate cash flow in various economic climates. This disciplined, long-term approach has served us well, and we believe it remains the most prudent path for preserving and growing wealth in the years ahead.
Eric Wathen, CFA®