Market Commentary Q4 2025
Market Commentary Q4 2025 – Spend To Grow
We would stop short of characterizing current investor sentiment as feverish, but optimism around capital spending, both in the U.S. and globally, continues to support near-term growth expectations for equities.
In the U.S., investments tied to artificial intelligence have fueled an acceleration in corporate earnings growth. Since the fourth quarter of 2022, the four largest hyperscalers have collectively spent nearly $1.3 trillion on capital expenditures and research and development, much of it related to generative AI and largely within their own ecosystems. These capital investments are expected to accelerate further into 2026 and 2027.
To date, the economic benefits of this spending have largely accrued to companies building AI infrastructure rather than those deploying it. The long-term returns on these investments remain uncertain and may take years to assess. This also represents a shift for these businesses, which historically achieved growth with relatively low capital intensity.
Adding to this uncertainty, in our view, is the growing complexity of how AI investments are being financed. While the overall amount of spending funded by debt remains relatively low compared to other capital-intensive cycles, funding sources are beginning to shift from cash-financed toward debt-financed. History suggests that transformative technologies (railroads, internet, etc.) have rarely been built without excess. Given the scale of capital flowing into AI infrastructure today, it seems unlikely this cycle will be an exception.
Even if the future opportunities for AI appear transformational, we would expect the market to face a growth scare at some point. Power generation and grid capacity may also act as natural governors on AI-related investment, potentially tempering the pace of deployment over time.
With this theme underlying investor sentiment throughout 2025, market performance remained notably narrow. This drove further concentration within the S&P 500, increasing the market’s sensitivity to a small subset of technology companies.
From November 30, 2022 (release of ChatGPT) through year-end 2025, the S&P 500 returned approximately 75% on a total return basis, while the equal-weighted S&P 500 index rose roughly 37%. In other words, most stocks underperformed the index, and by a large margin. As a result, the weight of the ten largest companies in the index increased from 26% at the end of 2022 to approximately 41% by the end of 2025, a record high.
Valuations for U.S. equities are elevated relative to long-term averages, but profitability is also meaningfully higher. Importantly, the bulk of the market’s gains in 2025 were driven by earnings growth rather than multiple expansion. For valuations to reset materially lower, we would likely need to see a sustained decline in margins or a meaningful deterioration in top-line growth expectations. That said, the durability of earnings growth has become increasingly central to the market’s strength.
Global equity markets experienced a meaningful improvement in sentiment last year, particularly in Europe and Japan, where starting expectations were arguably very low. Fiscal stimulus initiatives and a renewed emphasis on pro-growth policies have helped stabilize growth outlooks in both regions. Local interest rates have risen over the past few years, likely reflecting improved growth expectations. Surprisingly, European banks have managed to outperform U.S. technology companies since the release of ChatGPT. Starting valuations matter, as does the shape of the yield curve in the case of banks.
Even so, developed international market returns in 2025 were driven primarily by U.S. dollar depreciation and valuation expansion rather than earnings growth. While forward expectations have improved, actual earnings momentum remains muted. Over the long term, we believe earnings growth will be the primary driver of equity returns, a dynamic that remains more challenging for developed markets outside the U.S. given what we see as structural advantages for U.S. businesses.
The broader macroeconomic backdrop remains mixed. Consumer spending has held up better than sentiment would suggest, supported largely by higher-income households. Sentiment among lower-income consumers remains extremely weak, likely due to the lingering effects of cumulative inflation.
Labor market conditions have also softened at the margin. While headline employment remains relatively strong, leading indicators such as job openings and hiring intentions have moderated. Against this backdrop, the Federal Reserve has shifted toward a more accommodative stance. Short-term interest rates have declined following recent cuts, while longer-term rates remain elevated amid lingering concerns around fiscal spending. Corporate bond spreads have tightened back toward historically low levels as the equity market rallied back to all-time highs.
Following three exceptional years for equities, it is reasonable to question how much longer strong returns can persist. On the surface, valuations appear stretched. Digging deeper, however, we believe opportunities remain for patient, long-term investors, particularly in U.S. mid and small cap equities. Valuations for smaller companies reflect a challenging earnings environment over recent years, which could improve with lower interest rates, broader economic momentum, and/or productivity gains tied to AI or otherwise.
Market leadership in 2025 was characterized by the underperformance of quality, a core pillar of our investment philosophy. Periods of lower-quality outperformance often coincide with elevated risk appetite and confidence in sustained growth. While such environments can persist, we believe durability is eventually repriced as capital costs normalize and investor focus shifts back toward sustainable profitability.
Our focus remains on identifying businesses with durable earnings and sustainable returns on capital. Despite a more challenging valuation environment, we continue to see opportunities to invest in quality businesses at prices we believe are reasonably attractive relative to fair value today.
Authored by: Jack Holmes, Chief Investment Officer
DISCLOSURES: Thought Leadership Disclosures
