“Someone will always be getting richer than you. This is not a tragedy.”
– Charlie Munger, longtime partner of Warren Buffett
Fourth Quarter Summary
During the fourth quarter, financial markets exhibited volatile and uneven progress as the autumn months approached.
- Both U.S. and global equities showed positive returns, featuring previously laggard groups like cyclicals and smaller cap indices.
- Fixed income again had modest returns, with little change from 10-year Treasury yields. Meanwhile, the 2- to 10-year yield curve steepened.
- Commodities became quite mercurial, WTI oil continued lower. Metals soared, with silver having a parabolic blow-off late in December, partly due to limited liquidity.
Overall, markets continued the volatility that characterized 2025 as a whole. It was a rocky but highly profitable year for most investors.
The Government Shutdown and Tariffs
A key theme of the quarter was the unprecedented 43-day government shutdown. The economic cost due to layoffs and other factors led to fears of a hit to real GDP growth. Contributing to the concern was the delay of critical economic reports, leaving policy makers in the dark about the state of the economy. It was not until December that the full economic picture emerged showing little change from September statistics. Employment continued in a “no hire, no fire” environment while inflation seemed to be trending lower.
Revenues from tariffs helped lower the nation’s trade deficit considerably, though their status is being tested before the U.S. Supreme Court (SCOTUS). An adverse ruling could affect $133 billion out of approximately $271 billion in total tariff revenues. The Administration has already stated it has a “Plan B” to replace most of the lost funds, although implementation of the plan may take time.
Geopolitical Considerations
Global tensions simmered last year, with no major changes in the Ukraine-Russia war and Taiwan-China controversy. However, as 2026 dawns, new hot spots are appearing.
The U.S. captured and extradited Venezuelan leader Nicolas Maduro and his spouse in a daring military mission. The new acting President, Delcy Rodriguez, has agreed (with some reservations) to facilitate increased oil production and export to American refineries. President Trump is encouraging major U.S. oil companies to invest massively to upgrade Venezuela’s crumbling energy infrastructure. So far, however, the majors have been cautious, based on previous nationalizations of foreign oil assets by Caracas.
Iran is another hot spot as massive protests currently threaten the Islamic regime. There is a binary outcome scenario for oil, with one possibility a lifting of sanctions and a release of additional barrels. Another possibility would be a supply interruption and petroleum price increases. There are other repercussions, as both Russia and China are allies of Tehran.
More Fog with the Future of the Fed
Another “known unknown” is the future composition of the Federal Reserve Board. Officials at the White House have stated that a new Fed leader will be nominated by the end of January — one who likely favors lower short-term Fed Funds rates. There is also a Department of Justice investigation of Jerome Powell, which could have an impact if he stays on as a Fed governor when his term ends in May.
Still at issue is the status of Fed governor Lisa Cook, currently pending a decision by SCOTUS. If she is removed, observers believe her replacement will probably have a bias towards cutting rates. The future Fed Board members then, may likely reflect that bias.
There is also a push by the Administration to address elevated housing and credit costs through new policies. The details, however, are hazy at this time.
Current Status of the AI Trade
It appears that the market is beginning to differentiate Artificial Intelligence-related stocks as individual winners and losers, rather than as a group based on the latest headlines or sentiment. Winners appear to be companies spending funds out of current cash flow and earnings, while losers are firms that must borrow massively to finance their new technology. Other losers include areas such as software whose legacy businesses deemed to be at risk by AI.
Also, there is increasing evidence of AI usage by corporations, both internal and external. The AI phenomenon is now entering a new phase of development, rather than approaching its end. Of course, we are continuing to monitor red flags of the AI story that were highlighted in our October commentary. Fortunately, they are not present at this time.
The New Year Outlook
- The U.S. economy should accelerate in the first half of 2026, with the benefits of the new tax bill along with anticipated tax rebates stoking GDP growth.
- The jobs market continues to erode slowly, though layoffs will not swell meaningfully enough to threaten economic expansion.
- Inflation may moderate a bit early in the year due to distortions from the government shutdown but should begin to creep higher again later in 2026. Tariff impacts should largely be worked off by spring.
- The Fed will cut the short-term Fed Funds rate at least two to three times, probably later in the year.
- The 10-year Treasury bond yield should remain within the 4.00-4.50% range, creeping higher if inflation starts to increase.
- U.S. stocks should do well, possibly posting another year of above-average returns due to the stimulatory effects of the tax bill, lower Fed Funds rates and the AI story.
- Volatility will continue, with more headline risk out of Washington and geopolitical hot spots contributing to rapid moves in both directions. Additionally, mid-term election years (such as this one) tend to be more volatile than other years. Patience is required.