No Santa Claus Rally. Domestic markets narrowly notch positive returns as a weaker dollar propels non-US markets into record levels.
Market Update
KEY OBSERVATIONS
Economic data surprises: The third quarter (Q3) gross domestic product expanded at an annual rate of 4.3%, marking the fastest pace in two years and significantly exceeding expectations. Reports of cooling inflationary pressures reinforced investor optimism.
Another rate cut: As widely expected, the Fed cut rates by 25bps (basis points), while the 9-3 split on the vote garnered much of the attention. Most committee members expect further rate cuts will be needed in 2026.
Non-US markets lead the way: International stocks posted their best outperformance versus U.S stocks since 2009 as a tumbling US dollar fueled the advance.
RECAP
Global stocks gained 1.0% in December to bring their year to date returns to 22.1%. The healthy advance marked the MSCI ACWI All Cap benchmark’s best calendar year performance since 2019, and its third consecutive year of gains. Cumulatively, global stocks have gained over 70% the past three years, rewarding patient investors following a challenging period in 2022.
By the thinnest of margins, the S&P 500 Index produced its 8th consecutive monthly gain. Value stocks, as represented by the Russell 1000 Value Index, outperformed their growth counterparts, as represented by the Russell 1000 Growth Index (0.68 % versus -0.62%). Small cap stocks, as represented by the Russell 2000 Index, underperformed large cap, as represented by the Russell 1000 Index (-0.58% versus 0.01%). U.S. equities moved higher, with the S&P 500 gaining 2.3%. Throughout the year, performance leadership remained heavily concentrated in technology and other growth oriented sectors, but there were signs late in the year of market broadening, particularly in value tilted and international markets where cheaper valuations and improving fundamentals attracted investor interest. Expectations that the Fed and other major central banks could deliver further, albeit moderate, policy easing in 2026 helped sustain investors’ risk appetite and provided a supportive backdrop for equities as the year drew to a close.
Overseas, the MSCI EAFE Index, representing non-U.S. developed markets, outperformed the U.S. with a 3.0% advance as the US dollar fell to its lowest level in over three years. The dollar fell over 1.1% in December, to bring its full year decline to 9.4%, its sharpest annual retreat in eight years. Emerging markets, represented by the MSCI Emerging Markets Index, performed admirably with a 3.0% increase driven by gains from the technology-oriented markets of Korea and Taiwan. The calendar year gain of 33.6% was the best annual showing for the index since 2017.
US Bonds slipped nearly 0.2% in December but finished the year up 7.30%, its best performance since 2020. Longer-term interest rates rose during the period, despite the Federal Reserve cutting its target rate, as economic data came in well ahead of expectations. The move higher in interest rates negatively impacted long-duration assets, which are more sensitive to interest rates.
LOOKING AHEAD
Investors digested a steady stream of headlines this year: tariffs and “Liberation Day” in the spring, the passing of the “One Big Beautiful Bill,” the Federal Reserve resuming rate cuts after a nine-month pause, and an autumn government shutdown that, among other disruptions, delayed key economic data. Despite the noise and uncertainty, the economy continues to grow, consumers continue to spend, and the corporate backdrop remains healthy. The true wildcard, however, lies in the impending leadership change at the Fed in May, when Powell is set to be replaced by President Trump’s nominee. While the successor has yet to be named, it is widely assumed that the new chair may favor a more aggressive push toward lower interest rates than currently envisaged. Despite the noise, we anticipate the year ahead will bring gradual shifts rather than sweeping change. With strong foundations in place, most portfolios need only modest adjustments, underscoring a timeless principle that sometimes, no action is the best action. While modest adjustments may be warranted, we believe current positioning reflects a balanced approach to downside risks and upside potential in 2026.
