A good year or a terrible, horrible, very bad year?
As we approach the end of another exhausting, event-filled year, it is a good time to take stock of 2025. Has this been a good year in the markets and the economy?
By the standards of the markets, 2025 was an excellent year. Through December 3rd, and including dividends, the S&P 500 Index is up 18%, the Nasdaq Composite Index is up 22%, the Russell 2000 Index (small-cap stocks) is up 14%, and the MSCI ACWI ex-USA Index (international stocks) is up 29%. US fixed income has had a strong year as well, with the broad investment-grade bond market up about 7%. These are generous returns, both on an absolute level and relative to history.
By the standards of the overall economy, 2025 has been more mixed but still positive. The US economy is growing. Unemployment is a bit over 4%, low by historical standards. Consumers are still spending. Inflation has come down from 2022 but has leveled off at about 3% (the Federal Reserve would like to see this closer to 2%).
At the same time, a long-standing measure of consumer confidence – the University of Michigan Consumer Sentiment Index – is now near historic lows. Another measure of consumer confidence – The Conference Board’s Consumer Confidence Index – fell to its lowest level since April, right after the shock of “Liberation Day”.
So, if the economy looks fine, and if the market is a forward-looking vehicle that reflects optimism about the future, why, then, does everyone seem so miserable?
“Miserable” is not, of course, a very precise, technical term. Maybe a better word is anxious. And different participants in the economy are nervous for different reasons.
First, the vast majority of the country is still feeling the pain from the inflation spike in 2021-2022. While it’s true that the rate of inflation has decreased dramatically since 2022, the cumulative effect of high inflation still persists as price levels are markedly higher now, particularly in sectors of the economy like housing, food, and transportation.
Second, and related to the above, the tariffs have contributed to higher prices, and the unpredictability of the tariff policy has created uncertainty among consumers, especially concerning major purchases like cars.
Third, the government shut-down contributed to the negative sentiment, although the end of the shutdown helped improve the mood slightly.
Fourth, non-financial factors are undoubtedly contributing to the sense of unease: the persistence of deep political divisions within the country, heightened geopolitical risk around the globe, and a stagnant labor market for many white-collar industries (even though the headline unemployment number is strong).
Finally, there is another key factor creating unease, which may not be as prevalent as inflation in the minds of most Americans, but which we have been hearing about in our conversations with PMA clients (as we do our own admittedly anecdotal and unscientific survey): this market is not cheap, and it is concentrated in a handful of mega-cap technology companies that have been spending enormous amounts of money on artificial intelligence. Adding to this anxiety, as it always does, is the financial press, full of stories about similarities to 1999, with the clear implication being we are headed for a downturn in the market.
It’s no wonder that readers of the financial press who track the valuation levels of the market are wondering whether this is a good time to reduce risk by shifting money from equities to bonds, to which we would offer the following responses:
- Even if it is true that the market is overvalued and concentrated in a few stocks, this does not guarantee that a market correction will occur in 2026. In December of 1996, the Chairman of the Federal Reserve Alan Greenspan caused a temporary global panic by saying there was too much “irrational exuberance” in the markets. But the markets recovered quickly and it took three more years to vindicate Greenspan’s comments when the tech bubble burst in April of 2000. Meanwhile, the S&P 500 rose over 100% between 1997 and April of 2000. It is very, very difficult to time the market.
- Current valuation levels are better at predicting longer-term returns. We are more comfortable saying that the rich pricing of the market today will more likely produce modest, single-digit returns for US equities over the next five to ten years than we are predicting the timing, depth, and recovery of the next, inevitable correction.
- Markets move in cycles. From 1982 through 1999, one of the longest bull markets in history, the market generated returns of about 19% per year. Then, from 2000 through 2009, the same S&P 500 had a negative annualized return. And then, from 2010 through today, the S&P has returned approximately 14%. Are we poised for another period like 2000 through 2009? It is very possible, but we do not know when or how it will unfold.
- Markets go up more than they go down, as this great chart from the website “The Visual Capitalist” illustrates. And when they do go down, they usually recover fairly quickly.
- Reducing risk is most appropriate where there has been a major change in a person’s life circumstances, or their appetite for risk has changed. Accept that, like Alan Greenspan in 1996, this decision may be right but early. Accept that there will be a feeling of some regret if the market continues to rise.
- Finally, despite the mood of the country and the state of the world, and despite whatever mood you may be in yourself, we believe that, as the saying goes, “this, too, shall pass”. Even though these are highly uncertain times, it is easy to forget that investing has always been a risky proposition. But those investors with the patience and discipline to weather these periods have been rewarded in the past (and we believe will be rewarded in the long-term future).
We wish you and your families a restful and joyous holiday season as we close out 2025.
