When Wall Street is not equal to Main Street
2025 was a classic example of the disconnect that can occur between the economy and wall street. Many small businesses struggled to adapt to chaotic tariff decisions, forcing many to continuously make decisions with only partial information or partial outlooks. The year brought a bit of whiplash for anyone making import decisions, consumers attempting to budget and sometimes made it difficult to find their favorite products. Yet, despite the dire outlook in March/April when the markets were down double digits, there was a remarkable rally that brought the U.S. to finish the year in double digit territory.
Global markets performed even better from a US dollar perspective with both emerging markets and developed markets up over 30%. They were bolstered in a significant way (from the US perspective) by a depreciating dollar since that contributed to about half of the return outperformance compared to a U.S.-only benchmark. International markets have experienced an approximately 17 year period of underperformance, so while there was a material margin of outperformance coming from overseas, the valuation gap still remains large. However, these divergences tend to be decades in the making, but even if that gap continues to (finally?) narrow, we believe the depth and strength of the U.S. markets (particularly the revenue generating engines of big U.S. tech) does warrant some level of risk premium.
Small cap stocks and value companies lagged larger and growth companies during the year. The concentration of the U.S. indexes in the top 10 names continues to be near historic highs, and it leaves many questioning whether the Magnificent 7 can or will continue to leave small companies in the dust. What factors might cause a role reversal? If successes are made with A.I. for big companies, could that lead to even more trouble for small-cap companies struggling to keep up, or could it instead start to shift down stream to benefit small companies?
Bonds saw mid-single digit returns with interest rates declining modestly. Municipal bonds struggled in the first quarter of the year, but they made up ground in the fourth quarter relative to the broader bond market. The yield curve is much steeper in municipal bonds, and duration is longer, so a sustained decline in interest rates may provide a small tailwind in the new year if that trajectory can continue, although economic and inflationary challenges in 2026 remain. While rates are lower in municipals, it is the after-tax return that investors get to keep in their pockets that is attractive, so opportunities remain for those in the higher tax brackets.
Read on as we explore current market levels, interest rates and uncertainty. Happy New Year!
Diversification – alive and thriving again
While the markets marched higher, there were plenty of assets that struggled to keep up – often an actual healthy sign to market movements, since few things should cause everything to move up (or down) indiscriminately. The broadening of the rally in the middle of 2025 from just the Magnificent 7 was also a positive sign. And, even some big-tech names struggled: Oracle still finished the year positively despite having a large decline during the quarter. Cryptocurrencies were one of the asset classes that did experience some setback during the year.
Fortunately, international exposures potentially made up for the lag that small cap and mid cap U.S. companies experienced. The market dynamics of the last decade have tested previously tried and true portfolio construction themes. International public markets lagged the U.S. for the better part of 17 years, and many small caps were left in the dust in 2025. Small cap companies often see cyclical periods of time of either outperformance or underperformance – the 1980’s saw small cap stocks go on a tear – largely since they had almost nowhere to go but UP given the 90% declines in the 70’s. But, in today’s world, technology has shifted the lifecycles of many companies – instead of a somewhat natural progression of a company from small to mid to large in a clean(ish) path, many companies now have private liquidity sources and scalability potential that helps them jump from micro/small cap companies to large or meta cap companies overnight. Can/will existing small caps rally strength or are they among some of the fallen that will find it difficult to accelerate to greater success?
Despite the large rally that has continued since 2022, from a forward price-per-earnings perspective, price multiples are only 3% higher than they were in early 2022. So, much of the meteoric rise in the last three years has been driven by a substantial increase in per-share earnings.
Since markets look forward into the decades ahead, current news often tends to cause unexpected swings but they normalize as people can assess and adjust the long term impact that it may cause. One dramatic shift in the year was the large scale layoffs from big tech in anticipation of an A.I. boom. Large companies in many ways are attempting to shift from hiring (as evidenced by the low jobs growth in 2025) to capital expenditures to keep up. Often, markets overreact (both positive and negative) in the short term, but they tend to understate the truly transformative nature of new technologies on daily living, the economy, and corporate ingenuity for new products, revenue streams, and efficiencies over the long-term since it is quite unpredictable.
While valuations do remain on the high side, they are nowhere near the sky high valuations from the tech bubble. With the cash generating engines that the Magnificent 7 represent, they have thus far largely self-financed A.I. investments in recent years.
Where do we go from here?
Inflationary pressures persisted and challenges remain ahead – the inflation rate edged up to 2.7% in November from having hovered around 2.3% in the spring (Source: BLS). But, interest rates did decline meaningfully throughout the year. The Fed funds rate started 2025 at 4.25 – 4.5% and ended at 3.5-3.75% (Source: Federal Reserve) which has helped consumers and companies to lower their borrowing and financing costs and alleviate the pressure from higher rates of the last few years.
The key to navigating market environments like this is to have a solid plan in place that features enough tools in the toolkit that allow you to adapt. It’s when you plan during the positive environments when it seems like not a lot can go wrong that allows you to get through the environment to the other side when (not IF) times get difficult. Your asset allocation and emergency reserves are what allow you to get a handle on short term events – that you live through in real time – to (1) not be a forced seller in a distressed environment, and (2) to be patient for opportunities that can arise – whether it’s using cash set aside for such dislocations, selling defensive assets during a crisis to act on more compelling long term opportunities, or even as simple as being ready to rebalance portfolios (an important tool to us and our clients as least!). Each action above can allow someone to switch their mindset from throwing their hands up and submitting to the environment vs. one who can remain calm, making more rational decisions and being opportunistic.
But, by having those plans outlined now, it allows you to remain calm and collected when conditions shift. That has value in and of itself by helping reduce the emotional toll we all can fall victim to when dealing with struggles in real-time. Hopefully you have an advisor in your corner that can help you strategize now.
What could your plan benefit from? To help avoid being a distressed seller, taking the time to carefully strategize a Plan B and C (and even Plan D!) is well worth the effort when things otherwise are positive. Since, people often HAVE liquidity when they don’t NEED it, yet don’t have (or get) liquidity when they actually want it. So, having backup plans for other credit facilities, strong emergency fund(s), identifying specific assets that may hold up better in a market rout that could be a source of liquidity, or just having sufficient wiggle room in your discretionary expenses are all good tools to have at your disposal. And, knowing how/when/if/why you might utilize those tools helps improve the chance that you can actually take the action needed if circumstances change swiftly (as they often do at those points in time). Whether it’s preparing for a business contingency or just your own personal lifestyle and expenses, planning ahead has significant value since some strategies may have tax impacts or other further-down-the-line imparts that would be good to know and understand before the pressure moment is upon you to have to react and a snap decision doesn’t take into account key considerations.
And, even if one path is “stay the course”, that can often prevent making short term adjustments (when it feels like you SHOULD sometimes), and instead keep that lens focused on your long term optimum chances of success.
CLOSING REMARKS
It is a fallacy to think the next environment will be any more predictable than the last one, so building a plan that is only optimized for one solution – i.e. just focusing on a continued market rally, or just on an imminent market downturn – means you may miss most of the environment that actually will happen. Building resilient plans is a foundation to our philosophy even when it seems like markets can do no wrong. It was only three years ago in 2022 that both bonds and stocks were down double digits for the full year. It’s hard to see when markets are positive how they could be anything but, yet times consistently show it pays to be patient in both good and bad times.
When markets make new highs, FOMO is real. Feel like you’re missing out on the gold and silver rush of the last year? How could you not when gold was up over 60% and silver was up more than double THAT (up over 140%). It sure can seem like missing out on the rally, but in reality, for the decade leading up to 2025, the S&P 500 was up over 240% (2015-2024) while gold was up less than half that at 113% and silver was “only” up 75%. So, gold and silver had a meteoric rise in 2025 but they were mostly playing “catch-up” (for what, who knows?) from the last decade. And, despite the rise, gold still underperformed U.S. large-caps. Don’t bother trying to include the time since the Global Financial Crisis since the U.S. large-cap market dwarfed silver and gold (hint, it’s not even close). So, who really missed out? Those that didn’t invest in long-term companies with great earnings and growth prospects.
There was a lot of uncertainty throughout the year, but you wouldn’t have noticed that if you only studied the volatility for the U.S. stock markets – which remained at relatively low levels of 15-20 (as measured by the VIX) – in the last six months of the year. A bit more subdued than the first six months of the year. Markets remained pretty calm despite significant political headlines and technology sector layoffs. Is it the calm before the storm? Maybe the storm is benign, but maybe something more sinister is lurking. Either way, there’s no better time when you can be clear headed to understand your plans limitation(s), inventory and safety measures for your gear and lifeboats.
Plan for the worst, but hope for the best – that’s our foundational view on helping optimize chances of success in the future since the future is anything but knowable!