Winter 2026 Market Commentary
By Marc Usem and the Affiance Financial Investment Committee
Climbing a Wall of Worry
The S&P 500 experienced significant volatility in 2025, with a 4% decline in the first quarter, followed by strong sequential gains in the remaining quarters to finish the year nearly 18% higher. The fourth quarter saw the weakest gain of the three up quarters with 2.65% growth, mostly generated during October. With such strong performance, most investors forget that the market was down nearly 20% in April of 2025, due to the announcement of 150% tariffs on “Liberation Day.” A quick pivot by the White House walked back the size and timing of tariffs and set the stage for a strong stock market rally during the rest of the year.
International and emerging markets led the U.S. market last year, a trend which continued in the fourth quarter with gains of about 4% for international developed markets and 4.75% for emerging markets. Full year returns were nearly double U.S. market returns with emerging markets up 34% and developed international markets up 31.5%. Global portfolio diversification was clearly a significant benefit in 2025.
Bonds also provided strong returns in 2025 with the U.S. Aggregate Bond Index gaining 7.3%, or nearly twice its dividend yield. Returns were enhanced by falling interest rates, which move opposite of bond prices. The 10-year U.S. Treasury rate fell by nearly 9%, from 4.6% at the start of the year to 4.2% at year end. While we may not see a repeat in 2026, depending on inflation and Fed policy, we expect bonds likely will earn their coupon of about 4%.
The question on most investors’ minds is, “can the bull market continue?” The old adage, “Markets climb a wall of worry,” was on full display during the second half of the year. Pundits and analysts flooded news outlets with concerns of an AI bubble. The culmination may be comments by Michael Bury, from The Big Short, who, in mid-December, noted that he is now shorting selected AI stocks.
We agree that the current AI race will likely end poorly at some point with overbuilding and excess capacity, but when and by how much is unknown. In the meantime, we expect AI to continue to power markets higher – albeit with increasing volatility. That does not imply that there are not excesses among AI companies, but that the largest companies driving stock index performance appear to have reasonable valuations and earnings expectations.
One of the most significant risks to continued market strength is rising inflation, which has remained subdued as manufacturers and retailers absorbed much of the new tariffs. Some estimates are that companies have absorbed 50% to 80% of tariffs, but this trend may moderate as companies begin passing on more of the tariff impact to consumers. The risk to markets may be compounded if rising inflation dampens the Fed’s current rate cutting cycle, which markets expect to continue, as well as by the uncertainty surrounding the President’s appointment of the next Fed Chairman in May. Geopolitical risks many also induce stock market volatility, including the U.S. incursion into Venezuela, which may embolden other global leaders’ ambitions such as China in Tiawan and Russia in Ukraine.
We believe that long-term investors remain best served by selecting an asset allocation that reflects their risk profile while remaining patient and disciplined. We know we can’t control or time the markets, so we remain focused on our disciplined investment processes to provide well-designed, tax-efficient, globally diversified portfolios that suit our clients’ investment planning needs.
Thank you for your continued confidence in our work.
Sources: YCharts, Morningstar, CNN, Google, Business Insider, Yardeni Research, Econofact, Affiance Financial, Federal Reserve History
The views represented in this commentary are not meant to be construed as advice, testimonial or condemnation of any specific sector or holding. Investors cannot invest directly in an index. Unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Different types of investments involve varying degrees of risk. Past performance and detailed processes do not guarantee future results. Please remember to contact Affiance Financial if there are any changes in your personal/financial situation or investment objectives. Asset allocation, rebalancing, and diversification will not necessarily improve an investor’s returns and cannot eliminate the risk of investment losses.
