2025 Fourth Quarter Stock Market Update

Well, That Was Interesting…What Now?

January 2026

This past year brought a dizzying series of events. We had DOGE, tariffs, the Middle East, the “Big Beautiful Bill”, the Fed and all things artificial intelligence (AI) give way to a dramatic swoon and even more dramatic recovery (oh and don’t forget a government shutdown that markets largely ignored). In fact, it’s truly hard to believe we fit everything into one year! Ultimately, all the action culminated in another year of surprisingly strong returns for the broader equity indices. The S&P 500® Index and Russell 2000® Index finished 2025 up 17.9% and 12.8%, respectively, while the NASDAQ® Composite finished up 21.1%.

To review, the market started the year on a rough note with first quarter declines of 4.3% and 9.5%, respectively, for the S&P and Russell. Policy uncertainty, specifically DOGE and tariffs, weighed on investor sentiment. Declines went into overdrive in early April after “Liberation Day” and the official proclamation of steep tariffs on trading partners. At one point, the market declined 12% in just four days and was down 18% from its high. We then staged a stunning rally as tariffs were softened and DOGE faded into the background. Subsequently, gains were furthered as the economy remained strong, Congress passed Trump’s BBB and the Federal Reserve resumed interest rate cuts. All the while, AI was in the background fueling massive capital expenditures and stoking investor excitement.

Speaking of AI, technology and AI-related stocks led the charge again in 2025. The tech and communications services sectors advanced 23.8% and 32.5%, respectively, trouncing the rest of the market. AI darling Nvidia (NVDA), which now represents 8% of the S&P, was up 38.9% after a 171.2% gain the prior year. A steady stream of huge spending announcements from tech leaders helped induce the gains. Ultimately, a gold rush mindset seemed to develop across the AI ecosystem and we saw the fervor spread to more speculative corners of the market. So called MEME stocks, which gain popularity on social media, and unprofitable AI/tech stocks posted explosive moves higher. As seen in other investment crazes, people started betting on “stories” with little regard for the price they were paying. Case in point, 18 of the top 20 performers in the Russell 3000® Index from April 1st through the end of November were unprofitable companies!

We don’t doubt the promise of AI. Advancement and deployment of the technology may accelerate from here and bring new applications that are currently unfathomable. However, there are many risks and unknowns for investors. What could go wrong? For one, investors may begin to question how the leading players will earn adequate returns on massive capital outlays for computing power. Gartner projects global AI spending will reach $2 trillion in 2026. According to the Guardian, OpenAI is expected to spend $1.4 trillion over eight years whereas the company’s current revenue expectation for the end of 2025 is $20 billion. Much of the spending appears to be driven by FOMO (fear of missing out) and the path to returns is very unclear. Investor Howard Marks recently likened the spending boom to “building an airplane while it’s in flight.” We also note the landscape is rapidly shifting and many companies, including current leaders, could be upended by new business models as the technology advances. Whether it’s search engines, software or semiconductor companies, many of today’s winners could quickly become tomorrow’s losers (and vice versa). Hence, it seems foolhardy to think one can predict outcomes with a high degree of certainty.

We aren’t labeling this a bubble or calling for a top in AI-related stocks. While underweight technology in general, we own some of the large cap tech leaders and remain bullish on them. However, it does seem reasonable for this area, especially more speculative corners, to cool off after an extended run. While AI may be in the 1st or 2nd inning of development, valuations for many of the high-flyers appear to be in later innings and investor crowding seems extreme. We could either see a market rotation or broadening of returns. In other words, we could see investors gravitate to other areas of the market that have struggled. Many stocks, particularly in more economically sensitive areas, are beaten up despite the indices being near all-time highs. While the S&P 500, which has essentially become a large cap technology index, looks expensive at 22.1x forward earnings estimate, the equal-weighted S&P is much more reasonable at 16.7x. The stimulative effects of Trump’s fiscal policy could fuel improvement in more cyclical industries that have lagged. The same could be said for ongoing support from the Federal Reserve. Also helping, in 2026 we won’t have the noise of tariffs or DOGE, which seemed to cast a temporary pall over both consumer and corporate sentiment this past year.

We have been focusing much of our efforts on those stocks that have been cast aside as investors have focused elsewhere. It hasn’t paid recently to have differentiated perspectives or be valuation sensitive. Jumping on momentum bandwagons has proven much more fruitful. However, we believe the market’s sun could shine elsewhere some point soon and can’t stomach the risk associated with many of today’s highflyers. Our conservative approach has weighed on relative performance of late, but we’ve seen this type of market dynamic before (most notably in the late 1990s) and it ultimately paid to look where other investors weren’t looking. Thank you for your trust and all the best in 2026!

Sincerely,

George L. Smith III, CFA®
Chairman, Investment Policy Committee

Market Returns	Q4 2025	YTD
U.S. Large Caps	2.7	17.9
U.S. Mid Caps	0.2	10.6
U.S. Small Caps	2.2	12.8
International Developed Markets	4.9	31.2
Emerging Markets	4.7	33.6
Intermediate Term Bonds	1.2	7.0

Source: Morningstar Direct. Please see below for index definitions.

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Important Disclosures

Diversification and Asset Allocation does not ensure a profit or guarantee protection against a loss. Any opinions expressed here are statements of judgment on this date and are subject to future change without notice. This information may contain forward looking predictions that are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. There is no guarantee that a company will continue to pay a dividend. The investment return and principal value of an investment will fluctuate. Small and mid cap company stocks may be more volatile than stocks of larger, more established companies. The portfolios may invest in foreign securities which are subject to additional risks such as currency fluctuations, political instability, differing financial standards and the potential for illiquid markets. The information provided in this letter should not be considered a recommendation to purchase or sell any particular security.

Performance shown is historical and is no guarantee of future results. Investing in securities carries risk including the possible loss of principal.

Data as of 12/31/2025. Sourced from Morningstar and FactSet financial data and analytics. ©2026 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

Index Definitions: U.S. Large Caps represented by the S&P 500 Index. U.S. Mid Caps represented by the Russell Midcap® Index. U.S. Small Caps represented by the Russell 2000® Index. International Developed Markets represented by the MSCI EAFE Index. Emerging Markets represented by the MSCI EM Index. Intermediate Term Bonds represented by the Bloomberg Intermediate Government/Credit Index.

The S&P 500 Index is comprised of 500 U.S. stocks and is an indicator of the performance of the overall U.S. stock market. The S&P 500® Equal Weight Index (EWI) is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight – or 0.2% of the index total at each quarterly rebalance. The index is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). The Nasdaq Composite Index measures all Nasdaq domestic and international based common type stocks listed on The Nasdaq Stock Market. The Russell 3000 Index measures the performance of approximately 3,000 stocks and includes all large-cap, mid-cap and small-cap US equities. The index is designed to represent approximately 98% of investable US equities by market capitalization. The Russell 1000 Value Index measures the performance of the Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Index measures the performance of the 2000 smallest companies in the Russell 3000® Index, representing approximately 8% of the total market capitalization of the Russell 3000. The Russell Midcap Index measures the performance of the 800 smallest companies in the Russell 1000^®, which represent approximately 25% of the total market capitalization of the Russell 1000. London Stock Exchange Group PLC and its group undertakings (collectively, the “LSE Group”). © LSE Group 2025. FTSE Russell is a trading name of certain LSE Group companies. “Russell^®” is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote/sponsor/endorse the content of this communication. The Morgan Stanley Capital International Europe, Australia and Far East (MSCI EAFE) Index is an unmanaged index composed of the stocks of approximately 1,000 companies traded on 20 stock exchanges from around the world, excluding the U.S., Canada, and Latin America. The Morgan Stanley Capital International Emerging Markets (MSCI EM) Index is a capitalization-weighted index of stocks from 26 emerging markets that only includes issues that may be traded by foreign investors. The reported returns reflect equities priced in US dollars and do not include the effects of reinvested dividends. The Bloomberg Intermediate Government/Credit Index is an unmanaged index composed of debt securities with maturities from one to ten years issued or guaranteed by the U.S. Treasury, U.S. Government agencies, quasi-federal corporations and fixed rate dollar denominated SEC-registered corporate debt that are rated investment grade or higher by Moody’s Investors Service and Standard and Poor’s Corporation or Fitch Investor’s Service, in that order.

An investor cannot invest in these indices and their returns are not indicative of the performance of any specific investment.