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Q4 2025 | A Quarter in Review
- Konner DeLeon
- 2 hours ago
- 5 min read
2025 Q4 MARKET INSIGHTS
The fourth quarter of 2025 started with the longest government shutdown in history. While government shutdowns tend to have no impact on the equity markets, uncertainty increased volatility until a deal was ultimately reached on November 12th.
International and emerging markets once again outperformed U.S. equity markets in Q4 and in aggregate, outperformed the U.S. equity markets for the full year in 2025.
To cap off the fourth quarter, U.S. equities sold off in their final four sessions of trading while foreign developed and emerging markets ended on a strong note.
KEY TAKEAWAYS
Investment Philosophy and Outlook
Artificial Intelligence dominated markets in 2025, but questions about earnings, valuations, and year-end weakness are on the forefront of investors' minds as we assess the Fed's soft landing in 2026.
Market Performance
U.S. equities posted solid gains for the year, but foreign developed and emerging markets outperformed for the first time in years. This was driven by a weaker dollar, better valuations, and U.S. policy pressures.
Fixed Income & Bond Market
The yield curve steepened as short-term rates fell and credit spreads stayed tight, supporting growth assets and helping the bond market deliver its strongest annual return since 2020.
Federal Reserve Guidance
The Fed cut rates twice in Q4 as inflation improved, GDP projections rose, and labor market cooling supported continued easing into year end.
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INVESTMENT PHILOSOPHY & OUTLOOK
Artificial intelligence (AI) continued to dominate the headlines in 2025. The boom in AI had a significant impact on market performance, but the big question is whether the massive capital expenditure into AI will translate into earnings growth and profitability. With the most recent growth we’ve seen in the space, the thought on everyone’s mind as we enter 2026 is whether there is an AI bubble. While it may seem like it, given high company valuations, this feels different since AI is producing revenue and profits, there is demand for AI, and more capital investments are needed to continue growing data centers and cloud capacity.
Moving into 2026, we will be watching markets closely to determine whether the pullback to end the year was routine year-end profit taking or the early stages of a broader sector rotation.
In addition to this, will the Fed's soft landing hold? We will be keeping an eye on payroll growth, unemployment, Personal Consumption Expenditures, consumer spending, and credit spreads. If we begin to see weakness in these areas, investors could begin to rotate into defensive companies that have high cash flow.
While geopolitical tensions are still high, their overall impact on the equity markets was minimal in 2025. Going forward, this will still be at the forefront of investors’ minds and something to watch.
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Market Performance
The Russell 2000 index, which tracks small cap companies, returned 2.2% in the fourth quarter and 11.3% for the year, the S&P 500 returned 2.71% this quarter and 16.39% for the year, the Nasdaq Composite returned 3.16% this quarter and 20.36% for the year, and the Dow Jones Industrial Average returned 3.66% for the quarter and 12.97% for the year.
The MSCI ACWI, which encompasses the U.S. markets along with foreign developed and emerging markets, returned 3.37% in Q4, bringing the full year return to 22.87%. The MSCI World index, which captures developed market countries returned 3.20% in Q4 and 21.60% for the year. The MSCI Emerging market index returned 4.78% in Q4 and 34.36% for 2025.
Both foreign developed and foreign emerging equites outperformed U.S. equities, which hasn’t occurred in the past 5+ years. This emphasizes the importance of holding a diversified portfolio that can capture returns across all sectors of the market.
The U.S. dollar had its worst performing year since 2017 which helped to lift foreign and emerging markets. We began to see some valuation gaps correct themselves as investors rotated to markets trading at lower multiples with higher expected returns.
Outside of this, U.S. policy and tariffs played a big role in returns for the year. They disrupted supply chains, increased uncertainty, and raised costs, which had a larger impact on U.S. firms than their international counterparts.
Fixed Income & Bond Market
In the fourth quarter, the yield curve steepened with short-term yield falling faster than long-term yields due to the Fed rate cuts. This steepening tends to signal improving economic expectations and reduced recession fears. The falling short-term yields boosted growth stocks, duration-sensitive assets, and high-quality bonds.
Looking at corporate credit spreads, which reflect how much extra yield investors demand to hold corporate bonds over treasuries, they continue to stay tight suggesting investor confidence. This helped to reinforce the Fed’s soft-landing message. If markets feared a recession, we would have seen the spread widen in the fourth quarter.
The Morningstar U.S. Core Bond Index, which is a proxy for the U.S. investment-grade bond market, ended the quarter with a gain of 0.97% and 7.12% for the full year. This is the highest gain since 2020. Overall, the bond market was relatively quiet in the fourth quarter. While treasuries performed well, investment-grade corporate bonds outperformed in 2025. Corporate bonds benefited from falling interest rates, strong corporate balance sheets, starting the year with higher yields, and tight credit spreads.
Federal Reserve Guidance
In the fourth quarter, the Federal Open Market Committee (FOMC) lowered the target federal funds rate by quarter percent in both meetings. This brought the target federal funds rate to a range of 3.50%-3.75% in December.
The U.S. economy continued to grow at a moderate pace with GDP projections being revised slightly higher. While inflation remained somewhat elevated in October, there was clear improvement with PCE (Personal Consumption Expenditures) and Core PCE projections being revised downward. The numbers are still slightly higher than earlier in the year, which has mainly been attributed to the effects of higher tariffs.
The labor market continued to cool with the unemployment rate edging up, and payroll employment increases slowing. Overall, this signals that there are softer labor conditions. The Fed sees the downside risk of rising unemployment and improving inflation trends, which helped to shape their decision to continue easing policy through the quarter.
In 2026, the consensus is that there will be 1-2 rate cuts, but overall, inflation is close to the Feds target, economic growth is still positive, and the overall job market is still healthy. Based on these factors, additional rate cuts could risk increasing inflation, overheating the economy again, and further weakening the U.S. dollar.
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DeLeon Wealth, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
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