Financial Markets Review

December capped a year in which U.S. equities delivered strong absolute returns but increasingly narrow leadership beneath the surface. Major indices finished the month modestly lower, with the S&P 500 snapping a seven-month winning streak and slipping 0.05%, the Nasdaq falling 0.53%, and the Russell 2000 declining 0.74%. The more telling development was the continued dispersion between high beta and low volatility. Since the Liberation Day trough in April, high beta and momentum stocks have overwhelmingly outperformed low volatility, and December was emblematic of that trend. The S&P 500 High Beta Index gained 3.31% during the month, while the S&P 500 Low Volatility Index fell 2.50%.

Several themes defined the month. The December FOMC meeting took center stage, alongside renewed scrutiny of the AI trade, mixed labor-market signals, evidence of continued disinflation, and resilient holiday-season consumer spending. Together, these themes reinforced that there is much to be constructive about in the economy, even as meaningful risks remain.

The Federal Reserve delivered a widely expected 25-basis-point rate cut, lowering the fed funds target range to 3.50%–3.75%. The decision was accompanied by a $40 billion per month Treasury bill purchase program, aimed at supporting liquidity without reintroducing full-scale quantitative easing. Three dissents underscored internal debate, with one governor favoring a larger cut and two preferring no change. Chair Powell struck a measured tone, noting that recent labor data may be overstating monthly job growth by roughly 60,000 positions while also acknowledging persistent inflation pressures tied to tariffs. His emphasis on flexibility rather than a preset policy path was interpreted as supportive, but cautious.

Recent economic data broadly validate that cautious optimism. December nonfarm payrolls increased by just 50,000, and downward revisions to October and November reinforce the view that job growth is slowing. The unemployment rate edged down to 4.4% from a revised 4.5% in November but remains above the 4% lows seen earlier in 2025. Inflation continued to trend lower, with November CPI at 2.7% year over year and core CPI at 2.6%, helped by easing housing costs. At the same time, consumer demand is becoming increasingly K-shaped. Higher-income households, supported by asset-price gains, continue to spend freely, while lower-income consumers face pressure from still-elevated prices and tighter financial conditions. This divergence is likely to persist into 2026, with implications for earnings and politics alike.

Looking ahead, the new year opens with several important policy developments. President Trump is expected to announce his nominee for the next Federal Reserve chair in the coming weeks, a decision that could influence expectations for monetary policy beyond the current easing cycle. Fiscal policy is also returning to the foreground following the passage of the One Big, Beautiful Bill Act in July, which effectively provides stimulus through tax cuts, accelerated capital-expenditure depreciation, and targeted spending measures.

Artificial intelligence remains a central driver of both market enthusiasm and risk. Competition among major platforms is intensifying, with new large language model releases expected from OpenAI and Meta in early 2026, alongside continued development of Alphabet’s Gemini ecosystem. Industry estimates suggest capital expenditures among the five largest hyperscalers could approach $600 billion in 2026, with roughly $450 billion directed toward AI infrastructure, representing growth of more than 35% from 2025. Funding these investments will require significant borrowing, and corporate debt issuance is expected to reach record levels, much of it tied to AI. Credit default swap spreads for segments of the U.S. technology sector have widened sharply since September, reflecting rising leverage and increasing scrutiny of returns on invested capital. Projections point to as much as $1.5 trillion in new technology-sector debt to fund these initiatives over the coming years, raising valid questions around capital discipline and ultimate payoffs.

Valuation remains the unavoidable backdrop as the calendar turns. Institutions such as the IMF and the Bank for International Settlements have warned about elevated asset prices. Data cited by the Financial Times and the data group Finaeon show the S&P 500’s Cyclically adjusted 10-year price/earnings (CAPE) ratio now exceeds levels seen before both the 1929 crash and the 2008 financial crisis, rivaled historically only by the 2000 tech bubble. U.S. equity market capitalization relative to GDP is at an all-time high, and technology stocks now account for roughly half of the market, with their value rising from 44% to 101% of GDP over the past three years. These conditions do not signal an imminent downturn, but they do suggest a materially thinner margin for error heading into 2026.

Tandem Strategy Update*

Over the past several months, we have spent considerable time discussing the forces pushing equities higher, with particular emphasis on the growing dispersion between the S&P 500 High Beta Index and the S&P 500 Low Volatility Index. The contrast is evident when looking at each index’s largest constituents. The High Beta Index is dominated by companies such as Micron Technology, Microchip Technology, AppLovin, Lam Research, and Tesla, while the Low Volatility Index is led by TJX, Waste Management, Evergy, Realty Income, and Coca-Cola—two very different sets of businesses reflecting two very different risk profiles.

After years of lagging performance, low volatility finally gained traction in the first quarter of 2025. That period, which already feels distant, was marked by elevated volatility and heightened uncertainty. In such environments, investors typically gravitate toward companies with more stable and predictable business models. As markets sold off, the S&P 500 Low Volatility Index rose 6.67%, while the S&P 500 High Beta Index declined 11.69%.

As volatility subsided and tariff concerns eased, equity markets staged a sharp V-shaped recovery and pushed to new highs. However, not all segments participated equally. Stocks that held up during the sell-off generally lagged in the rebound, while higher-beta and momentum-oriented stocks led the charge. From the second quarter through year-end, the S&P 500 High Beta Index surged 49.32%, while the Low Volatility Index declined 4.46%. While it is typical for high beta to outperform during recoveries, the magnitude of this dispersion was unusual. There are only a few times in history where the dispersion has been this wide and most of them occurred around the peak of the tech bubble in 2000.

Those familiar with Tandem know our strategies are more closely aligned with the low-volatility end of the spectrum. We focus on businesses that consistently grow revenues, earnings, and cash flows through any economic environment. In our Large Cap Core (LCC) strategy, companies must pay and grow their dividends. In our Equity (EQ) and Mid Cap Core (MCC) strategies, dividends are not required, but when paid, they must grow. Over the past year, companies in LCC grew earnings and dividends by an average of 14.13% and 10.20%, respectively. In EQ, earnings growth averaged 14.88%, with dividend growth of 10.43%. MCC companies delivered average earnings and dividend growth of 13.87% and 9.14%. Fundamentally, our companies did what we expect of them, even if they were not necessarily appreciated by the market for much of 2025.

As Benjamin Graham once said, “in the short run the market is a voting machine, but in the long run it is a weighing machine.” The low-volatility segment will become attractive again; the timing is unknowable. What is knowable is that maintaining discipline around owning durable, consistently growing businesses ultimately allows fundamentals to assert themselves, and patient investors to be rewarded.

*The transition level activity taken by Tandem is applicable to new manager-traded accounts and new money in manager-traded accounts, not the composite or firm-wide level. New manager-traded accounts and new money in manager-traded accounts are not automatically invested on the first day. Rather, they are transitioned into our strategy over a longer time period that is dependent upon market conditions, this process differs from Tandem’s model-provided strategies, where money is invested on the day the account opens. Strategy level activity is applicable to the composite and action is taken at the firm-wide level.

Source: Source of all data is FactSet, unless otherwise noted.

Print
Back to Archives

Disclaimer: Tandem Investment Advisors, Inc. is an SEC registered investment advisor.

This audio/writing is for informational purposes only and shall not constitute or be considered financial, tax or investment advice, or an offer to sell, or a solicitation of an offer to buy any product, service, or security. Tandem Investment Advisors, Inc. does not represent that the securities, products, or services discussed in this writing are suitable for any particular investor. Indices are unmanaged and not available for direct investment. Please consult your financial advisor before making any investment decisions. Past performance is no guarantee of future results. All past portfolio purchases and sales are available upon request.

All performance figures, data points, charts and graphs contained in this report are derived from publicly available sources believed to be reliable. Tandem makes no representation as to the accuracy of these numbers, nor should they be construed as any representation of past or future performance.​

This document was originally written/recorded in English. Tandem does not guarantee the accuracy, completeness, or reliability of any translated materials, and shall not be held responsible for any discrepancies, errors, or misinterpretations arising from the translation process.