2025 Market Recap
Strong Returns, Elevated Valuations, and Falling Rates Set the Stage for 2026
The investment landscape in 2025 delivered strong results across most major asset classes, defying a year that began with widespread concerns around tariffs, geopolitics, and economic slowdown. Resilient growth, solid corporate earnings, and a more accommodative Federal Reserve combined to support markets, even as valuations moved meaningfully higher. As we enter 2026, the key takeaway is not simply that returns were strong, but that forward-looking assumptions now require greater discipline, selectivity, and structure.
Equities: Resilience, AI Optimism, and Higher Starting Valuations
U.S. equities delivered another strong year in 2025. The S&P 500 returned +17.9%, finishing just below an all-time high and marking a +37% rebound from the April lows. Economic growth and corporate profits proved more resilient than many investors anticipated, despite ongoing tariff concerns and geopolitical tensions. Optimism around artificial intelligence was a key driver of the rally, though questions around valuation discipline and the risk of an “AI bubble” remain part of the conversation.
The Federal Reserve cut rates three times during the year, one more than initially projected, responding to a weakening labor market and subdued consumer sentiment, even as inflation remained above its 2% target. Mid-cap stocks returned +10.6% and small-cap stocks gained +12.8%, both underperforming large-cap equities but still delivering solid absolute returns.
All eleven sectors within the S&P 500 posted positive results. Communication services led with returns of +33.6%, followed by information technology at +24.0%. More defensive sectors lagged, with real estate returning +3.1% and consumer staples gaining +3.9%.
International markets outperformed the U.S., supported by a weaker dollar and more attractive starting valuations. Developed international (EAFE) markets returned +31.2%, with particularly strong performance in Europe at +35.4%, the U.K. at +33.6%, and Japan at +24.6%. Emerging markets gained +33.6%, driven by sharp recoveries in Korea at +99.8%, Brazil at +49.7%, and China at +31.2%. India, returning +2.6%, was the notable exception.
From a valuation standpoint, equity markets remain extended. The S&P 500 trades at +1.8 standard deviations above its historical forward P/E average, while the NASDAQ stands at +1.2, EAFE at +1.1, and emerging markets at +1.1. Forward earnings growth expectations are robust, with S&P 500 EPS projected to grow +11.3% over the next 12 months versus a 20-year annualized average of +6.9%, and NASDAQ earnings expected to rise +21.2% versus a long-term average of +10.7%. Across regions and market capitalizations, equities now trade at or above their 20-year average forward multiples.
Fixed Income: Falling Rates Support Broad-Based Gains
Fixed income markets also delivered positive returns in 2025 as interest rates declined across most of the yield curve. Investment-grade municipal bonds returned +5.9% following a volatile start to the year. The U.S. Aggregate Bond Index gained +7.3%, while U.S. investment-grade corporates returned +7.8%.
Higher-yielding segments performed well as credit spreads tightened. High-yield bonds returned +8.6%, with spreads compressing by 21 basis points, while bank loans gained +9.9%. Emerging market debt was a standout performer, returning +13.6%, aided by a weaker U.S. dollar and a 73 basis point compression in spreads.
Rates: Fed Cuts, Curve Normalization, and Shifting Expectations
Interest rates declined across most maturities in 2025, with the exception of the very long end of the curve. The Federal Reserve delivered three rate cuts during the year. The closely watched 3-month to 10-year Treasury spread widened by 29 basis points to +53, while the 2-year to 10-year spread widened by 36 basis points to +69, signaling reduced recession risk relative to prior years.
Outside the U.S., rates moved higher in Japan and parts of Europe, while falling modestly in the U.K. The Italian BTP–German Bund spread ended the year at 0.70%. Inflation expectations declined modestly, with 5-year breakeven inflation falling 12 basis points to 2.27% and 10-year breakeven inflation declining 9 basis points to 2.25%. The 10-year real yield fell by 33 basis points to 1.90%.
Looking ahead to 2026, markets are pricing in between two and three additional rate cuts, compared with the Federal Reserve’s guidance of one cut. By year-end 2026, markets expect the Fed funds rate to be approximately 3.04%, versus the Fed’s projected range of 3.25%–3.50%.
Currencies and Commodities: A Weaker Dollar and Strong Metals
The U.S. dollar experienced its worst annual decline in nearly a decade, with the dollar index falling –9.4% in 2025. Commodities rose +7.1% overall, despite a –5.1% decline in energy prices.
Precious and industrial metals led the complex. Gold surged +64.6%, while industrial metals gained +29.4%, driven primarily by copper, which rose +41.1%. Brent crude oil prices fell –18.5% to approximately $61 per barrel. U.S. natural gas prices increased +1.5%, while European natural gas prices declined –34.7%.
Market Conditions and Sentiment
Market volatility declined across both equities and bonds, with the VIX and MOVE indices finishing well below long-term averages. Investor sentiment remained constructive into year-end, supported by strong returns and improving financial conditions.
Looking Ahead
The experience of 2025 reinforces a familiar but important lesson. Markets can deliver strong returns even amid uncertainty, but elevated valuations reduce the margin for error. As kick off 2026, long-term success will depend less on predicting near-term outcomes and more on maintaining disciplined portfolio construction, prudent risk management, and a clear understanding of how each component of a portfolio contributes to long-term objectives.
At Ridgewood, our focus remains on building portfolios that are resilient across a wide range of economic environments, emphasizing structure, diversification, and fundamentals rather than short-term narratives. In a market shaped by optimism, innovation, and uncertainty in equal measure, that discipline matters more than ever.