Market and Economic Outlook - Released 12/31/25

Key takeaways:

• While uncertainty has persisted throughout the year which aided in falling confidence, the consumer continued to spend through it all and markets gave us another strong year of returns.
• Despite recent years of underperformance from small and medium size market capitalization stocks versus large cap stocks, a strong earnings growth profile and more attractive valuations have us preferring small and mid-cap companies versus large cap companies going into 2026. 
• Investors are not being adequately rewarded for taking additional risk in bonds. We maintain a core allocation to high-quality fixed income while limiting exposure to lower quality areas.

2025 reminded us that “typical” in markets often means anything but predictable. The year began calmly, but spring brought historic volatility driven by uncertainty around U.S. trade policy. Investors questioned the traditional safe-haven role of U.S. Treasuries, and we saw a rotation into non-U.S. assets and currencies.

Fortunately, fears of severe tariffs eased, inflation began to moderate, and optimism returned, fueled by massive investments in artificial intelligence technology. Midyear, the longest government shutdown in history disrupted economic data reporting, adding to uncertainty. Yet, the year closed on a calmer note as markets stabilized, and confidence improved.

"If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes." Warren Buffett's timeless advice reminds us that patience and discipline are key to building lasting wealth in any market environment. This long-term perspective is especially relevant today, as we are experiencing a period of immense innovation. From breakthroughs in innovative drugs that are redefining treatment for chronic conditions and even targeting healthy aging to the productivity gains fueled by artificial intelligence, the “good old days” are happening now. We believe these themes offer a wide range of investment opportunities that will define and shape the future of the global economy.

As we move into 2026, we’re keeping an eye on how expensive the stock market looks, especially the biggest companies in major indexes like the S&P 500. The economy and company profits still appear healthy, but because stock prices are starting from higher levels, future returns may be lower than what we’ve seen in the past.

In this environment, we have a slight preference for equities over bonds within multi-asset portfolios. However, given current valuations, selectivity is key. We favor mid and small-cap stocks relative to large cap stocks, where opportunities may be more compelling. At the same time, high quality bonds offer attractive yields and serve as a strategic complement to stocks for those focused on risk management.

Uncertainty persists as year closes

We began the year with uncertainty surrounding tariff announcement, and we will do the same on the way out but with different drivers. The fourth quarter commenced with the government shutdown which ended up lasting a total of 43 days, which is the longest government shutdown in history. While the shutdown officially ended on November 12, many of the economic data reports were delayed until after the Federal Open Market Committee (FOMC) meeting which left the investment community and the Federal Reserve to make their own assumptions on where inflation and the labor market stood heading into the final meeting of the year. Ultimately, the committee decided that the risk to employment on the downside was greater than that of inflation to the upside, and with that cut the Fed funds rate to a range of 3.50% to 3.75%.

Once the government reopened, we began to receive the backlog of releases. Inflation came in better than expected with both headline and core Consumer Price Index softening to a 2.7% and 2.6% yearly increase, respectively (though some economists have cited the government shutdown as reasoning for inaccurate data included in the release). The labor market, on the other hand, has cooled since the beginning of the year with payrolls showing a loss of 105,000 jobs in October followed by a gain of 64,000 in November. Job losses were driven by the Federal Government, which shed 162,000 jobs in October and another 6,000 in November. Private payrolls, conversely, have held up relatively well averaging 75,000 new jobs over the past three months. The unemployment rate jumped to 4.6% to end the year.

Shaking off the news

Consumer confidence continued to be weak ending the year with five consecutive months of declines in the index. Declines in consumer confidence this year, however, have not stopped the consumer from spending. Gross Domestic Product (GDP) increased by a robust 4.3% seasonally adjusted annual rate in the third quarter driven by a 3.5% increase in consumer purchases of goods and services. Retail sales, also affected by the shutdown, slowed in October showing flat sales over the month, though excluding autos and fuel, sales increased by 0.5%.

Despite the headlines, the market continued to march higher in the quarter led by international shares while the U.S. market in total returned 2.4%. We ended the year with new all-time closing highs for the S&P 500 (December 24). The U.S. market produced a third consecutive year of double-digit returns, up 17.9%, while international developed markets posted a total return of 31.9% which is their best performance since 2009.

As we head into 2026, we remain constructive on both the economy and the stock market. That said, we do not expect stocks to give us the types of returns we have seen over the last three years. With valuations remaining somewhat elevated, we expect returns to be closer to the historical averages. We received three rate cuts by the Fed this year, and through next year we would expect to get another one or possibly two. Those may not come at the beginning of the year as the market is expecting the Fed to take a pause on any rate movements for the first meeting or two.

Reflections on stocks

Major stock market indices finished 2025 on steady footing with the fourth quarter supporting strong returns across many different asset classes. As we move into a new calendar year, it is helpful to reflect on where equity markets were in 2025 while setting the stage for our outlook on various asset classes within stocks going forward.

International stocks shined after trailing U.S. peers in recent years by a substantial margin. While outperforming on the backdrop of a weaker dollar in 2025, international stocks still trail their U.S. counterparts significantly over a 10-year period having underperformed by nearly 164% since the end of 2015 (Figure 2). Currently, due to sector composition differences and, in our view, a lack of significant catalysts that would support persistent international outperformance versus U.S. stocks, we maintain a neutral outlook between domiciles. We continue to believe a meaningful allocation to international stocks that aligns with investor risk tolerance in a diversified portfolio makes sense across market cycles over the long term.

In 2025, the S&P 500 continued what has been a strong 3-year run with annualized returns of 23% over this time frame. While strong earnings growth has supported this rally, particularly earnings growth for companies exposed to Artificial Intelligence, it has also stretched the benchmark’s valuation on a next twelve-month price-to-earnings ratio (NTM PE) basis to near 20-year highs. This results in the S&P 500 NTM PE exceeding the S&P Small Cap 600 Index by nearly 50% over this time frame, which is a two standard deviation premium to small cap stocks, which may suggest rich valuations in large cap relative to small cap (Figure 3). Until some recent strength in the second half of 2025, small and mid-size company peers have not kept up with the pace of share price and earnings growth relative to large cap in recent years. We are beginning to see signs of this trend changing as 2026 consensus earnings estimates for both the S&P Small-Cap 600 and the S&P Mid-Cap 400 indexes are slated to exceed that of the S&P 500 according to FactSet data. Given a strong earnings growth profile and more attractive valuations, we prefer small and mid-size market capitalization companies versus large cap heading into 2026.

A look at alternative asset classes

In the fourth quarter, headlines were dominated by volatility in the precious metals market and cryptocurrency asset classes. Silver was up over 23% in December alone after an already strong 11 months previously, which contributed to the metal returning 141% for the year. Gold shined throughout the year as the metal returned 65% while hitting record highs. After a strong rally through October, the cryptocurrency, Bitcoin, fell -23% in the fourth quarter and ended 2025 down -6.5% for the year (Figure 4). There are a number of factors that led to the price action we have seen throughout the year in these alternative asset classes, but through the lens of our asset allocation framework, our primary takeaway is that we continue to maintain a preference for cash flow generating assets like stocks and bonds that are aligned with investment goals and a structured financial plan.   

Bond bounce

2025 marked a turning point for U.S. bonds. The Bloomberg U.S. Aggregate Bond Index advanced 7.3%, its strongest annual gain since 2020, supported by Federal Reserve rate cuts and easing inflation pressures. While Treasury yields ended the year lower, providing a tailwind for bond returns, the path was volatile at times. Rates spiked sharply in the spring amid trade and policy uncertainty, before retreating and oscillating within a range-bound pattern throughout the second half. By December, yields had declined from their highs, reinforcing the positive performance for fixed income (Figure 5). 

Quality over risk

Credit spreads, or the extra yield bonds offer over comparable U.S. Treasuries to compensate for risk, tightened to multi-decade lows earlier this year, supported by strong corporate fundamentals and demand for income. Recently, spreads have widened slightly, signaling caution amid renewed market volatility. Despite this, most fixed income sectors remain near historically tight levels, meaning investors are not being adequately rewarded for taking additional credit risk. Given this backdrop, our recommendation is to maintain a core allocation to high-quality fixed income while limiting exposure to lower quality areas.

Privately issued bonds—loans made directly to companies outside public markets—have attracted attention for their higher yields, which reflect greater default risk and lower liquidity. While most of these remain outside the traditional banking system, structural weaknesses such as weaker loan protections and limited transparency could create stress if economic conditions worsen. For most investors, focusing on high-quality bonds and avoiding overly complex bond structures remains the prudent approach.

The outlook for bonds in 2026 is constructive but nuanced. Following the Federal Reserve’s December meeting, policymakers signaled that interest rate cuts are likely in the first half of next year, but the path forward is not without debate. Recent changes in voting members and the appointment of a new Chair could introduce differing views within the committee. Some members favor more aggressive rate reductions to support growth, while others believe the current federal funds rate is close to a “neutral” level—neither strongly restrictive nor accommodative.

We feel short-term rates are likely to trend lower, while longer-term yields may stay elevated due to persistent inflation uncertainty, large fiscal deficits, and heavy Treasury issuance. Global factors, such as Japan moving away from near-zero rates, could also influence long-term rate expectations. Treasury yields are projected to remain in the 3.75%–4.50% range, kept elevated by ongoing government borrowing. With yields near multi-year highs and the potential for further rate cuts, high-quality fixed income offers compelling opportunities for income and portfolio stability though proactive portfolio adjustments may be needed.

The bottom line

As we enter 2026, the outlook is encouraging as the economy remains resilient, supported by strong growth and transformative innovation. These trends are creating new opportunities for businesses and investors and reinforce the importance of staying invested for the long term. While markets will continue to react to economic data and global events, history shows that a disciplined, long-term approach remains the most reliable path to success for the coming year and beyond. 

*Forecasted average annual returns of COUNTRY Trust Bank Wealth Management

Source: Morningstar and COUNTRY Trust Bank® - See Definitions and Important Information below

COUNTRY Trust Bank® Wealth Management Team

• Chelsie Moore, CFA, CFP® - Director, Wealth Management & Financial Planning
• Kent Anderson, CFA - Portfolio Manager
• Jonathan Strok, CFA - Portfolio Manager
• Michelle Beckler - Investment Analyst
• Samantha Reichert - Investment Analyst