Market Review
The benchmark S&P 500 index closed the 4th quarter up 2.3% to mark a third consecutive quarterly gain and take appreciation for the full year to 16.4%. That market movement tracks with earnings results continuing to top expectations and forecast to grow at a double-digit pace in 2026. Corporate earnings beat the consensus outlook by over 6%, growing at over 13% year-over-year, marking a fourth consecutive quarter of double-digit growth. Revenues surprised more modestly, by slightly over 2%, growing over 8% versus the prior year. Analysts project that earnings expanded almost 8% during the 4th quarter and will grow at more than 12% during the 1st quarter of 2026. The Federal Reserve (“the Fed”) cut their policy rate by 0.25% at each of their three meetings during the 4th quarter. After the December meeting, Fed Chair Powell offered his view that the Central Bank has acted sufficiently to stabilize the labor market while their policy rate is high enough to continue weighing on price pressures.
The Economy
The U.S. economy posted a second consecutive quarter of robust growth at 4.3% for the 3rd quarter after expanding 3.8% in the 2nd quarter. Economists had projected growth of only 1.0% at the start of the 3rd quarter. Per the Federal Reserve Bank of Atlanta’s GDPNow model estimate, 4th quarter economic activity will increase by around 3%. Inflation readings on the Central Bank’s preferred Core Personal Consumption Expenditures Deflator remain low by historical standards but linger in a tight range above the stated 2% target. The Fed’s post-meeting statement in December indicated that they expect stable inflation during 2026 and no material increase in the unemployment rate into next year. Economists anticipate the U.S. economy will grow a below-trend 1.0% during the 4th quarter and a trend-like 2.0% in 2026. The unemployment rate remains 1.2% above the cycle low of 3.4%, and remains quite low by historical standards, even during times of solid economic growth. A recent influx of job seekers has expanded the labor force and exerted upward pressure on the unemployment rate. Interest rates on maturities five years and shorter fell modestly during the 4th quarter relative to the 0.75% aggregate move from the Fed, but did not likely not have much incremental impact on economic growth.
Equity Markets
The S&P 500 topped most sectors during the 4th quarter, trailing only Healthcare (+11.2%) and Communication Services (+7.0%). The two leading sectors outpaced the index by a sizeable margin, while Energy and Real Estate finished in negative territory for the quarter. The recently ended quarter marks the first time since the 3rd quarter of 2018 that Healthcare ranked as the top-performing sector, as there has long been a regulatory cloud hanging over Pharmaceutical and Health Insurance companies. While regulatory changes haven’t necessarily been positive for those sectors, the finality of knowing what the rules will actually be has removed the sort of uncertainty that investors find unpalatable. Communication Services posted a strong quarter, as stalwart Alphabet (GOOGL/GOOG) has become seen as the artificial intelligence (“A.I.”) front-runner and is a huge portion of the sector’s market value. Financials (+1.6%) posted solidly positive returns, as the market sees a friendlier regulatory backdrop that could allow Banks more lending capacity and encourage financial market activity like mergers and acquisitions (“M&A”). Though investors have become increasingly wary of the immense amount of money being committed to building out data centers and A.I. infrastructure, the secular change toward accelerated computing continues to be a tailwind for the Tech sector (+1.3%), as both hardware and software enable that shift. Industrials (+0.5%) and Materials (+0.6%) continue to benefit from that data center buildout, providing equipment, materials and technical expertise to power construction. Industrials also benefit from efforts to strengthen the existing power grid and expand the grid to provide electricity to data centers. Consumer (+0.1%) spending remains resilient in spite of moderating job growth, and robust year-over-year growth in holiday spending helped boost stocks in the sector. The Energy sector has faced headwinds from lower crude oil prices, but demand for natural gas and liquefied natural gas (“L.N.G.”) for power generation remains quite strong. Real Estate trailed all other sectors on the lack of positive catalysts relative to other pockets of the stock market, though the prospect of potentially lower interest rates could make the sector’s typically generous dividend payouts look more attractive.
Long-Term View
Equity strategists are almost uniformly bullish as the stock market turns into the new year. It’s likely that investors will feel less optimistic at times over the course of 2026, but such is a typical year, with ebbs and flows. As we enter January with everyone seemingly reading from the same script, what does seem certain is that the next year will not play out exactly as that script would dictate. As seasoned investors are well aware, the markets and the macro backdrop will have some surprises in store, some positive and some less so. A new Fed Chair will take the helm during 2026, pending Senate approval, and that transition could cause some ripples as markets adjust to the new leader’s communication style and policy leanings. The macro backdrop is by and large positive, with Fed members indicating that they see the likely room to allow for some additional fine-tuning rate cuts and the stimulative fiscal package passed in 2025 beginning to hit for households and corporations alike. Companies head into the new year on the heels of several consecutive quarters of consensus-beating financial results. Commentary during the 4th quarter give no reason for pause on that front, and analysts are forecasting double-digits earnings growth for 2026. Stock prices and earnings may not move in lock step, but as the above graphic reminds, they do tend to sync back up should they diverge for a time. The air is calm, but best that investors fasten seatbelts in case of turbulence that seems to appear even during years that produce attractive returns.
