New Year, New Paradigm?

TRANSCRIPT

Happy New Year! I hope your year-end festivities were joyful. I recently marked my 31st year in investment management — January 1995 feels like a lifetime ago. Let’s quickly review the “just completed” 2025 and then shift our focus and provide a summary of our 2026 outlook.

Last year, the S&P 500 returned 17.88% —another good year for investors in U.S. stocks, but not without some hand-wringing. From late February to early April, the S&P 500 plunged approximately -20% peak-to-trough, touching bear market territory. As investors digested the potential tariff impacts, equity markets recovered. Interestingly, in 13 of the past 20 years, the S&P 500 has experienced an intra-year peak-to-trough drop of at least 10%; however, only 3 of those years produced a negative calendar year return. A reminder that short-term volatility is normal.

It has been an impressive run for the S&P 500 over the past decade; annualized returns for 3-, 5- and 10-year periods have exceeded market expectations and historical averages.

In 2025, growth outperformed value, large outperformed small and mid-cap, the tech-heavy NASDAQ was up 21.17%, and in a change from recent years, international developed stocks outperformed U.S. stocks. All major bond indices finished the year in positive territory with higher yield and longer duration strategies leading the way. Commodities were mixed; gold was a big winner while crude oil was down.

Corporate profits exceeded expectations and interest rates declined, especially on the short end as the Federal Reserve cut the Fed Funds Rate three times in 2025.

Chart 1, 2:11— All things considered, a good year. Looking forward, equity markets are near record levels, reflecting solid earnings and improving visibility on inflation and policy. Technology continues to lead, but other sectors are gaining momentum. High U.S. valuations may trigger volatility. RBC Rochdale expects S&P 500 corporate earnings to grow 12.5% in 2026. Our base case for the S&P 500 to reach between 7,600 and 7,700 by year end is driven by earning growth, fiscal and monetary stimulus and a resilient consumer. Key areas are listed down the middle with possible positive and negative scenarios.

While U.S. valuations remain elevated, relative opportunities abroad are becoming more compelling as earnings expectations rise and currencies stabilize. Given the improving outlook, we plan to introduce an allocation to developed international equities.

Chart 2, 3:14— U.S. stock valuations are historically wide relative to international markets, suggesting an entry point for non-U.S. allocations. Foreign governments are increasing spending with an emphasis on defense and infrastructure. The capacity for fiscal and monetary stimulus is greater in global markets due to lower rates and smaller debt loads. Declining U.S. interest rates and a softer dollar have historically driven strong performance in international markets. The U.S. market has become somewhat top-heavy with mega-tech and infrastructure companies constituting a disproportionate weight in the S&P 500, and international allocation will add to portfolio diversification.

We enter 2026 confident in the outlook for continued returns. Return dispersion remains high, making diversification and disciplined risk management essential.

Market leadership is shifting from policy-driven toward a broadening AI investment cycle that is now spreading across the economy. Geopolitical risks persist, but markets remain resilient as conflicts stabilize and a longer-term global shift improves non-U.S. opportunities. Tariff impacts are diminishing as negotiations lower rates and steady trade flows, suggesting domestic policy may be a smaller driver in 2026.

We remain constructive on equities, emphasizing AI-enabled and earnings-resilient sectors such as tech, communication services and energy, while maintaining caution in rate-sensitive areas.

Here’s to a prosperous, healthy, and happy 2026.