Quarterly Market Update: 2025 Q4

Market Summary

As we wrap up 2025, markets have once again proven resilient amid a year filled with policy shifts, political headlines, and evolving economic conditions. Investors have navigated new trade tariffs, anticipated Federal Reserve rate cuts, and a temporary government shutdown — all while corporate earnings and consumer demand have remained broadly stable.

U.S. stocks continue a steady rebound from their April lows, despite the tariff uncertainty that continues to loom over the economy and the equity markets. The chart below shows the S&P 500’s valuation grew to 22.8x of forward earnings compared to 22.0x at the end of June. International stocks bested U.S. stocks with an impressive run in 2025 thanks to their more attractive valuations, a weakening U.S. dollar, and rotation of investor capital away from high concentrated U.S. tech stocks. U.S. bonds have performed well this year as inflation has eased and the Federal Reserve has started cutting rates, driving yields lower and bond prices higher. Investors have also sought the stability and income of fixed income amid equity volatility and geopolitical uncertainty.

The AI Boom or the Next Dot-Com? Why Every Bubble Awaits Its Catalyst

The rapid rise of artificial intelligence–related stocks has fueled growing concern that markets may be entering an AI bubble reminiscent of the late-1990s dot-com boom. I first wrote about the rise of AI in July 2023, and two years later investors are starting to voice concerns that a bubble is forming. Investor enthusiasm for generative AI, data infrastructure, and semiconductor companies has driven valuations to record levels, often outpacing earnings growth or realistic adoption timelines. While the technology is undeniably transformative, history reminds us that when innovation and speculation move at different speeds, asset prices can detach from fundamentals.

The comparison to the dot-com bubble is natural — both periods are characterized by groundbreaking technology, massive capital inflows, and narratives of a “new economy.” However, today’s environment also shows important differences. Many of the leading AI companies are profitable, with strong balance sheets and proven products, unlike many internet startups of the late 1990s. Corporate investment in AI productivity tools, automation, and data analytics has tangible value creation, suggesting that while some exuberance exists, not all of it is misplaced. The charge below shows capital expenditure (capex) continuing to grow at an exponential pace not only in the dollar amounts being invested, but also as a percentage of companies’ operating cash flow.

Ultimately, every bubble needs a catalyst to burst — a shift in sentiment triggered by rising rates, disappointing earnings, or regulatory pushback. For the AI sector, that catalyst could come if revenue growth fails to meet the lofty expectations embedded in current stock prices. Until then, investors should remain mindful of valuations, focus on sustainable business models, and remember that even transformative technologies can experience painful resets on the road to long-term adoption.

Looking Forward

As we enter 2026, markets are transitioning into a new phase defined by three key forces: the Federal Reserve’s rate cuts, shifting global trade policies, and the resilience of corporate earnings. After an extended period of tightening, the Fed’s move toward lower rates could support housing, credit-sensitive sectors, and equity valuations. Still, the timing and pace of these cuts will depend on whether inflation continues to cool without triggering a broader slowdown. Meanwhile, renewed tariffs and evolving trade alliances are adding complexity to supply chains and input costs, keeping investors focused on how companies adapt to maintain margins.

Looking ahead, corporate profitability will remain the backbone of market stability. Many firms have managed to sustain earnings through efficiency gains and strong balance sheets, but moderating growth and higher costs could test that durability. While short-term volatility is likely, we remain constructive. A disciplined, diversified, and tax-aware approach continues to be the most reliable way to build and preserve wealth through changing market cycles.

1. Forward P/E ratio is the most recent S&P 500 index price divided by consensus analyst estimates for earnings in the next 12 months, provided by IBES since March 1994 and FactSet since January 2022. Shiller’s P/E uses trailing 10-years of inflation-adjusted earnings as reported by companies. Dividend yield is calculated as consensus estimates of dividends in the next 12 months, provided by FactSet, divided by the most recent S&P 500 index price. EY minus Baa yield is the forward earnings yield (the inverse of the forward P/E ratio) minus the Bloomberg U.S. corporate Baa yield since December 2008 and interpolated using the Moody’s Baa seasoned corporate bond yield for values beforehand. ↩︎
2. Data for 2025, 2026 and 2027 reflect consensus estimates. Capex shown is company total, except for Amazon, which reflects an estimate for AWS spend (2004 to 2012 are J.P. Morgan Asset Management estimates and 2012 to current are Bloomberg consensus estimates). *Hyperscalers are the large cloud computing companies that own and operate data centers with horizontally linked servers that, along with cooling and data storage capabilities, enable them to house and operate AI workloads. **Reflects cash flow before capital expenditures in contrast to free cash flow, which subtracts out capital expenditures. ↩︎