Summary
Another Winning Year: Our Monthly Survey of the Economy, Interest Rates, and Stocks The year 2025 was another good period for stocks. Following capital appreciation of 24.2% in 2023 and 23.3% in 2024, the S&P 500 increased 16.4% in 2025 (up 17.8% on a total-return basis including hypothetical dividends). The index has put together two consecutive winning years 16 times since 1960. Third-year returns after the two winners, however, have averaged just 3%. On that basis, 2025 beat the odds. Most indices and many stocks rose in fairly steady fashion from April 2025 through the end of October. While the S&P 500 did touch a new all-time high in December, the index level was little changed in the final two months. What did change, however, was relative sector momentum, as investors cashed out AI winnings and plowed them into neglected sectors, most notably Healthcare. All sectors were positive in 2025. And the delta between growth stocks and value stocks was in single-digit percentages, compared with a 20%-plus premium for growth over value in 2024. A market weighted toward the three traditional growth sectors might have had a bumpy entrance into the new year. But we believe improved sector diversity sets the market up for a smoother transition into 2026. The Economy, Interest Rates, and Earnings The federal government is back up and running, and we finally have access to preliminary 3Q25 GDP data. The Bureau of Economic Analysis (BEA) did not issue an advance (first) third-quarter 2025 GDP report. The preliminary (second) 3Q25 GDP report indicated annualized growth of 4.3%, better than the 3.2% consensus forecast and representing continued expansion from healthy 3.8% growth in 2Q25 GDP. The preliminary report was stronger than already-high expectations and appears to signal fundamental strength in the economy that superseded any challenges from tariffs, reduced immigration, and other factors. The increase in third-quarter 2025 GDP reflected increases in consumer spending, exports, and government spending. These positives were offset by a decrease in gross private domestic investment. Imports, which are subtractive to GDP, decreased. Third-quarter 2025 personal consumption expenditures (PCE) increased 3.5%, better than Argus’ expectations in the 2% range. In 2Q25, PCE rose by 2.5%. Total spending on goods increased to 3.1% in 3Q25 from 2.2% in 2Q25. Durable goods spending increased 1.6% in 3Q, while non-durable goods spending increased 3.9%. Durable goods spending was down from 2Q, while non-durable goods spending was up. Relative strength in non-durable goods spending likely reflects the much-discussed K-shaped economy, where lower-income consumers have focused their spending on necessities. Services, which is the biggest spending category at 45% of total 3Q25 GDP, rose by 3.7% in 3Q after a 2.6% gain in 2Q25. Non-residential fixed investment, the proxy for corporate capital spending, grew at a subdued 2.8% annualized rate in 3Q25, down from 7.3% in 2Q25 and from 9.5% in 1Q25. The AI boom drove 5.4% growth in both equipment and intellectual property products, but corporate spending on structures declined 6.3%. PCE and non-residential fixed investment normally constitute 80%-85% of GDP. These two categories contributed 2.8 percentage points to 3Q25 GDP growth. Residential investment declined 5.1% in 3Q25, its fifth decline in the past six quarters. Exports surged 8.8% in 3Q25, while imports contracted 4.7%. Both first- and second-quarter GDP featured outsized swings in the imports and private inventory categories due to trade positioning ahead of the implementation of tariffs. The third quarter of 2025 was expected to be the first period in which those two categories did not meaningfully distort overall GDP growth, but it appears that some trade-positioning impacts may have lingered. The net of exports and imports added 1.59 points to GDP growth, while the change in private inventories subtracted 0.22 percentage point. Government spending rose 2.2% in 3Q25 after being down 0.1% in 2Q25. Federal spending was up 2.9%, led by 5.8% growth in national defense spending. State and local spending increased 1.8%. The core PCE price index (excluding food and energy) rose 2.9% in 3Q25, in line with the Argus estimate of 3.0%. The change in core PCE prices is in-line with the 3.0% range prevailing since summer 2025. Outside the GDP accounts, the September and November nonfarm payrolls reports showed some recovery from the weak and worrisome summer jobs growth, but also some worsening in unemployment. There was no standalone October non-farm payrolls report. The November report included some October data but not an October unemployment rate. According to the Bureau of Labor Statistics (BLS), the U.S. economy generated 50,000 new non-farm jobs in December, up from a revised 56,000 in November and below the consensus forecast of 60,000. In October, the U.S. economy lost a downwardly revised 173,000 jobs. Many of the October job losses were from federal employees laid off in winter 2025 who had exhausted their severance. Based on December and November payrolls and the steep decline in October, non-farm payrolls averaged a decline of 22,000 for October-December, compared with an average gain of 22,000 for the September-November period. Federal employment has declined by over 270,000 since January 2025. With federal employment now relatively stable, the total employment picture is less likely to see outsized impacts from policy changes such as those affecting October 2025 employment. The unemployment rate eased to 4.4% in December from (revised) 4.5% in November. Average hourly earnings grew 3.8% annually for December, rising from a 3.5% annual rate for November. The breakeven level of jobs growth, required to hold the unemployment rate steady, is now lower than the 150K range in recent years because of trends in population growth. Due to sharply reduced immigration and secular decline in native-born birth rates, the St. Louis Fed now estimates breakeven employment growth of 32,000-82,000 per month. Thus, job gains in the neighborhood of consensus estimates would likely keep unemployment stable. Other reports delayed by the shutdown have now been released. The November all-items consumer price index (CPI) rose by 2.7% annually, while the core CPI increased by 2.6% from a year earlier. Both all-items and core CPI rose 0.2% month over month. While monthly and annual CPI growth were better than consensus, formerly stubborn categories such as shelter (one-third of CPI inputs) and airfares notably declined. Economists blamed a shortened data-collection period for incomplete data and expect the December CPI to paint a truer picture of consumer inflation. Based on sentiment surveys and diffusion indices, the business community appears guardedly optimistic while consumers are worried about new jobs scarcity. The ISM’s manufacturing purchasing managers’ index (PMI) fell from 48.7% in October to 48.2% in November, the lowest in four months. ISM’s services PMI rose from 52.4% for October to 52.6% for November, which was the highest reading in nine months. The Conference Board’s consumer confidence index fell to 89.1% in December from 92.9% (revised) in November. Within this series, the expectations index reading held steady at 70.7% for both November and December while remaining below the 80% threshold that some investors believe signals a recession ahead. The consumer sentiment survey from the University of Michigan finally rose month over month, to 52.9% in December from 51.0% in November. This consumer sentiment reading was 74.0% a year earlier in December 2024. Given the positive trend in GDP growth across the middle quarters of the year, Argus Chief Economist Chris Graja, CFA, has raised the Argus GDP growth forecast to 2.5% for 2025 from a prior of 1.9%. Chris has also increased the Argus GDP growth forecast for 2026, to 2.0% from a prior 1.9%. The U.S. Federal Reserve is tasked with the dual mandate of optimizing employment while keeping inflation in check. After raising rates aggressively throughout 2022 and early 2023, the Fed maintained its policy rate at 5.25%-5.50% from September 2023 until August 2024. Beginning in August 2024, the Fed cut rates by a cumulative 100 bps over the next three FOMC meetings. It then moved to the sidelines for the first nine months of 2025. The central bank then cut the fed funds rate in September 2025 and again by a quarter point each at the end of October and in the middle of December. After the October meeting, Fed Chair Powell stated that a December rate cut ‘was not a foregone conclusion.’ While a cut was indeed made in December, the Fed chair issued commentary that was similarly cautionary. Many investors now believe the December 2025 rate cut will be the last under Jerome Powell, whose tenure as chairman ends in May 2026. The Fed appears to have determined that the balance of risks had shifted away from rising prices and toward weakness in the employment economy. The recent trend in monthly non-farm payrolls growth signals at best uncertainty and at worst weakening in the employment situation. U.S. Treasury yields were little changed in September and October before moving lower in November in anticipation of a December rate cut. Rates continued moving lower at the short end in December while edging higher at the long end. The 10-year Treasury yield was 4.14% as of the end of December 2025, compared with 4.09% as of the end of November. The cycle peak for the 10-year yield was 4.9% in October 2023. The two-year Treasury yield was 3.45% as of the end of December 2025, versus 3.51% as of the end of November 2025. The cycle peak for the two-year yield was 5.2% as of October 2023. Over the course of 2025, the 10-year yield declined by 43 basis points (bps); and the two-year Treasury yield declined by 80 bps. The two’s-10’s spread at year-end 2025 showed a positive slope of 69 basis points, up from 32 bps at year-end 2024; a negative (inverted slope) 41 bps at year-end 2023; and a negative 48 bps at year-end 2022. The two’s-10’s slope in the yield curve at year-end 2025 was the most positive since year-end 2021 (79 bps), before inflation emerged and the Fed began its inflation fight. Argus expects short-term yields to move lower from current levels, although the pace of decline could moderate if the Fed stands pat through the end of Powell’s term. A more aggressive approach from a new Fed chair, however, could get short rates moving down again. Long yields over time are expected to widen their relative premium to short yields. With the Fed now done for 2025, Argus Fixed Income Strategist Kevin Heal continues to model one rate cut in in 2026. We see little likelihood of first-half rate cut and an increased likelihood of a second-half 2026 rate cut as leadership changes hands at the Fed. In the absence of government data, calendar 3Q25 earnings season had an outsized and largely positive impact on stocks. Expectations heading into earnings season, for high-single to low-double-digit growth, were the most positive in at least four quarters. Third-quarter 2025 earnings season was better than those positive expectations. The annual growth rate for calendar 3Q25 earnings was in the mid-teens range, with different agencies reporting slightly different rates. More than 82% of companies reported earnings above the pre-reporting consensus, which is higher than the long-term 75% average. The magnitude of the EPS beat against expectations, in the high-single-digit range, was above the midpoint of the long-term range of 5%-9%. The best growth in 3Q25 earnings season came from the Information Technology, Financial, Utilities, Materials, and Industrials sectors. The weakest sectors included Consumer Staples, Healthcare, and Energy. The single-digit decline in Energy earnings is actually the most moderate of any quarter in the past year. Revenue growth in high-single-digit percentages for 3Q25 was also the best in over a year. Nearly all sectors are growing revenue, which is partly a reflection of still-present inflation. An analysis of earnings-call transcripts suggests that while tariffs are still a topic, they are no longer the all-consuming topic. The overall message was positive, with earnings for calendar 4Q25 expected to rise in high-single-digit percentages. Third-quarter earnings season also featured expansion in non-GAAP operating margins to the 12.4% range, which is up about 50 bps year over year. Companies have learned to live with or at least navigate around tariffs, by sourcing locally to end markets and flexing variable costs whenever possible. Assuming the S&P 500 can sustain recent revenue growth exceeding 5% annually, we see room for further margin expansion ahead as volume leverage supersedes higher costs and tariffs. We are reiterating our forecasts for S&P 500 earnings from continuing operations of $270 for 2025 and $300 for 2026. Our preliminary forecast for 2027 earnings from continuing operations is $325. Domestic and Global Markets The major indices rallied steadily from April through the end of October. Although the S&P 500 pushed to fractionally higher all-time highs right before Christmas, the index generally back-filled across November and December and finished 2025 below all-time highs. The S&P 500 was up 17.8% on a total-return basis in 2025, while the index price finished about 1.2% below its all-time closing high. The Nasdaq delivered total return of 21.2% in 2025 and finished about 3% below its all-time closing high. The Dow Jones Industrial Average finished 2025 up 14.9% and finished less than a point below its all-time high. Wilshire Large-Cap Growth was up 23.4% as of the end of 2025, while Wilshire Large-Cap Value was up 17.0% at the end of the year. In a clear sign of year-end rotation away from growth names, the growth-to-value premium narrowed to 6.4%, compared with 24.2% for 2024. The Russell 2000 was up 12.7% for the year, as small-caps lost some steam in the final quarter. The Barclays Bloomberg U.S. Bond Index was up 6.9% in 2025, easing from its highest level of the year attained in November. Bond returns could continue higher in 2026 particularly if a new Fed chair adopts a more accommodative monetary stance. The S&P 500 edged up 0.1% in November before declining 0.1% in December on an index price (not total return) basis. But that does not mean nothing happened in the market in those two months. AI winnings were redeployed into other sectors into year-end. Fourth-quarter stock performance at the sector level shows where some of those AI winnings went, while an analysis of full-year performance suggests that investors are not giving up on the AI trade altogether. For 4Q25, the best sector performer by far was Healthcare (IYH), which rose 10.9% in the quarter. The S&P 500, by contrast, rose 2.3% in 4Q25, with all of that strength coming in October. The Healthcare sector has been helped by President Trump’s intervention to lower the monthly price of GLP-1 drugs and to strike pricing deals with other major drug companies. Four other sectors were positive in 4Q25: Materials, Information Technology, Financial, and Industrial.Utilities, which was strong for most of the year, declined in 4Q25 after Fed commentary signaled the potential for fewer rate cuts ahead, at least until Mr. Powell steps down. Other sectors that were down in 4Q25 included Real Estate, Consumer Staples, Communication Services, and Consumer Discretionary, while Energy was unchanged. The AI trade showed some cracks in the foundation during the fourth quarter of 2025. Nvidia released its highest-ever revenue and adjusted EPS for its fiscal 3Q26, beat the 3Q26 revenue consensus by billions, and guided fiscal 4Q26 revenue billions of dollars above consensus. But the NVDA shares fell post-earnings, dragging the AI trade down with it. The redeployment of AI winnings during 4Q25 had the effect of smoothing the overall sector map for full-year 2025. As of the end of 2025, all sectors were positive. Sectors that rose in single-digit percentages for 2025 included (in ascending order) Real Estate, Consumer Staples, Consumer Discretionary, and Energy. Sectors that rose in double-digit percentage for 2025 included (in ascending order) Materials, Healthcare, Financial, Utilities, Industrials, Information Technology, and Communication Services. The rise of generative AI is sort of turning every company into a technology company. But there are still a few sectors that sell the digital pickaxes to the AI gold rush. Information Technology has been the chief beneficiary of the AI economy. As of the end of December 2025, the Information Technology sector was 34.4% of overall S&P 500 market capitalization – up two percentage points in a year, but dow
