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

Market Commentary Q3 2025

Tech Spending Fuels Growth & Sentiment

The S&P 500 finished the third quarter up 14% year-to-date, and nearly 35% from the April 8^th bottom. From the lows in October 2022, the index has now doubled on a total return basis. Supported by the resilience of corporate earnings and the tailwind of artificial intelligence spending, investor sentiment appears to have shifted back to risk-on.

To this point, most of the capital deployed, or to be deployed, towards AI infrastructure has ostensibly come from the robust cash flow of mega-cap tech companies. During the quarter, leverage was added to the equation, following the seminal announcement from OpenAI and their debt-fueled partnership with Oracle. While accelerating capital spend is seen as a necessity by the various tech leaders to maintain or improve their competitive “moats”, risks from excess spending, both private and public, appear to be increasing. 

At some point, companies will need to justify the returns on these extraordinary investments to shareholders. Up until now, the largest technology companies have been widely viewed as capital-light, cash-generative, which makes the hurdle rate for returns on these investments that much higher. For now, they seem to be getting a free pass in funding what appears to be a race to superintelligence. 

The U.S. economy is largely dependent on consumers, which generate nearly 70% of gross domestic product (GDP). Yet, so far this year, capital spending in data centers has provided a comparable level of economic output. The accelerated investments by technology companies in cloud infrastructure and artificial intelligence has created a potential tailwind for economic activity and corporate profits. Thus far, those profits are primarily accruing to the technology companies involved in the infrastructure build-out. In theory, this may eventually lead to broader economic productivity and corporate profitability. 

Consumer spending has been somewhat of a corollary to the concentrated nature of the stock market, in that the top end of the consumer is exhibiting much better behavior than the bottom end. The top 10% of the income distribution accounted for 49% of consumer spending in the second quarter. Low-income consumers are beginning to pull back on spending, likely due to a slowing labor market, sticky inflation and housing affordability. Upper-income household spending remains more resilient, likely supported by the “wealth effect” of higher home prices and a strong equity market.

The employment market, one of the more reliable forward-looking indicators for the economy, is sending cautionary signals. Unemployment spells are lengthening as job seekers struggle to find new opportunities, while job openings continue to trend lower. A weakening employment backdrop has given the Federal Reserve cover to resume rate cuts once again, which they did in September. The market is currently pricing in one additional rate cut in 2025, followed by further accommodative policy in 2026.

Corporate earnings have maintained their resilience, despite the uncertainty around tariffs. Second quarter results for S&P 500 companies vastly exceeded expectations, with 12% growth vs. the 5% expected as of June 30^th. While we have expected earnings and overall market breadth to improve, the majority of growth is still coming from the largest companies in the index, which has led to further concentration in the makeup of the S&P 500. As of September 30^th, the top 10 companies comprised over 40% of the index. 

From a valuation standpoint, the spectrum continues to widen. U.S. large-cap stocks trade at a significant premium to small and mid, which is at least partly justified by relative earnings strength. International equity valuations, while still mostly lower than the U.S., have meaningfully expanded year-to-date. Along with the dollar decline, this has led to significant outperformance of international stocks over the past year. Earnings may be expected to improve abroad, but returns have thus far come primarily from valuation expansion and currency translation. Over the long term, we believe earnings growth is the most important driver of equity market performance. 

More recently, we have started to observe an increase in investor speculation, including the relative performance of non-profitable technology companies. Momentum stocks have also meaningfully outperformed those exhibiting both quality and value characteristics over the past year.

While we need to be mindful of such speculative activity, we prefer to focus on the quality and earnings durability of the businesses we own or are likely to own. For the most part, those companies have executed better than our expectations coming into the year. In our opinion, the bar seems to be higher as we look out into 2026, which is requiring us to act with additional diligence and patience.

Authored by: Jack Holmes, Chief Investment Officer

DISCLOSURES: Thought Leadership Disclosures