Most analysts, including myself, began the year with trepidation. Stocks were pricey, tariffs would rise by a lot, immigration would be halted, and DC would be even more chaotic than normal. Economists were on recession watch. Surely stocks would fall. Wrong!
Despite all that, the economy grew about three percent in 2025 and corporate profits rose 13 percent. Long-term interest rates were little changed but short-term rates fell. Rising profits and falling interest rates explain the strength in stocks. The S&P 500 rose 2.3 percent in the fourth quarter and jumped 16.7 percent on the year. Corporate America successfully handled Obamacare, the move to green energy from the Inflation Reduction Act, and Tariffs.
Much of the economic growth came from consumer spending, mostly from higher-income Americans, and the Artificial Intelligence (AI) boom. Those accounted for 70 percent of GDP. The five largest hyperscalers are spending more than $400 billion in AI capital expenditures. That’s nearly as much as the 2008 bank and auto bailout!
Tech companies including Nvidia, Microsoft, Meta Platforms, and Alphabet drove the S&P 500 higher for most of the year. They are such a large component of the S&P 500 that the index is becoming a reflection of the promises and doubts about AI’s future.
Fortunately, in the fourth quarter there was a rotation to other sectors that were previously ignored. Financials, transportation, health care, and energy became leaders. Tech stocks retreated. Having more stocks participate in advances makes for a healthier stock market.
As always, there are worries. Inflation remains well above the Fed’s 2 percent target. If the Fed cuts rates too much then investors will expect more inflation. Is AI in a bubble that will pop? Will there be another government shutdown? Will tariff inflation arrive in 2026? And the one I’m most concerned about is will bond vigilantes panic over debt and deficits? There are always things to worry about.
That said, I’m more optimistic than a year ago. S&P 500 earnings estimates for 2026 are for 14 percent growth. Add in a Fed that is cutting interest rates into a growing economy and you have a tailwind for higher stock prices. Because of its tech exposure, a solid year might not be reflected in the S&P 500’s 2026 return, but the broadening trade to sectors that aren’t nearly as expensive would be good news for portfolio returns.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
