Disruption Without Derailment
The U.S. stock market confronted a series of powerful crosscurrents in 2025—political uncertainty, trade disputes, and rapid technological change—but still managed to extend a remarkable multi-year rally. The S&P 500 Index finished near record highs, delivering its third consecutive double-digit annual return.
And yet, it was anything but a smooth ride. Beneath the headline gains, the year proved challenging and, at times, unsettling for investors, marked by sharp drawdowns, sudden policy shifts, and frequent swings in sentiment. Markets were forced to reassess, recalibrate, and adjust course as new information arrived—often abruptly.
Policy shocks and tariff tremors
Much of the year’s disruption stemmed from the ebb and flow of the new administration’s policy agenda. Most notably, on April 2nd, Donald Trump announced a sweeping tariff regime that included punitive levies on a wide range of U.S. trading partners. Markets were rattled not just by the scope of the proposal, but by the growing realization that the administration seemed serious about upending the global trading system.
The reaction was swift and severe. Global stock markets suffered their steepest two-day decline since March 2020, when the coronavirus pandemic abruptly halted economic activity—and, coincidentally, global trade. The prospect of a debilitating trade war drove the S&P 500 down nearly 20% and unsettled the bond market, with longer-term Treasury yields spiking higher.
The administration quickly pivoted, pausing many of its tariffs for 90 days. That move established a pattern that would repeat throughout the year: aggressive rhetoric and threats followed by negotiation, exemptions, or delays. Over time, investors began to shrug at the more severe scenarios, viewing them as bargaining tactics rather than foregone conclusions.
Less damage than feared
By most estimates, the average effective tariff rate on U.S. imports now stands in the 10–15% range. While meaningfully higher than the 2–3% regime that previously prevailed, it remains well below the levels initially announced in the spring. Tariff exemptions, sourcing shifts, and a series of trade agreements helped blunt much of the potential impact.
Just as importantly, the dire outcomes many feared failed to materialize. Neither the sharp economic slowdown nor the inflation surge predicted by some forecasters has materialized. Businesses initially built up inventories ahead of tariff deadlines. Later, many chose to absorb part of the added costs rather than fully passing them on to consumers. A resilient economy and strong corporate earnings helped equities regain momentum in the second half of the year, despite persistent headline noise.
AI arms race
If trade policy introduced uncertainty, the artificial intelligence revolution provided a powerful counterweight. The rapid adoption of AI has emerged as a critical source of economic resilience—and another disruptive force in reshaping and supporting markets.
Data centers form the backbone of the digital economy, housing the infrastructure that powers cloud computing, streaming, and increasingly, AI workloads. As demand for data storage and processing power has accelerated, investment in data centers has surged.
Technology spending accounted for an estimated 40-50% of U.S. GDP growth over the first three quarters of 2025, helping mitigate softness in consumer activity. Since the release of ChatGPT in late 2022, the four largest hyperscalers—Amazon, Alphabet, Microsoft, Meta—have collectively spent roughly $1.3 trillion on capital expenditures and R&D. McKinsey estimates that an additional $5 trillion of data center investment will be required through 2030 to meet AI-driven demand for computing power.
Build it and they will come
Naturally, the sustainability of this investment spending wave has come under scrutiny. Critics have drawn parallels to the late-1990s tech bubble, when telecom companies built massive fiber-optic networks under the assumption that internet bandwidth demand would grow in a straight line. Instead, capacity raced ahead of demand, bandwidth became a commodity, prices collapsed and a highly levered industry unraveled—taking the stock market down with it.
Today’s AI buildout differs in several important ways. Unlike prior capital-spending booms, it is being financed largely with internally generated cash rather than debt. The companies leading the charge are profitable, cash-rich, debt-light, and supported by enormous recurring revenue streams. While their stock prices have climbed sharply since 2022, valuations remain well below dot-com extremes and are more defensible given superior profitability, cash generation, and growth prospects. Importantly, demand for AI computing power has thus far grown faster than the infrastructure needed to support it.
The real risk: returns, not solvency
As in the dot-com era, the key risk is whether the sector’s investment returns ultimately keep pace with capacity growth. Industry observers have rightly questioned the timing and magnitude of cash flows that will eventually result from trillions of dollars of AI investment. But unlike the late 1990s, today’s issue is not solvency—it is the possibility that expectations move ahead of realized returns, leading to a valuation reset.
As hyperscalers deploy ever-larger sums, free-cash flow margins and cash balances will gradually come under pressure. To sustain current valuations, markets will demand clearer evidence that AI investments will generate durable, financially meaningful returns for the hyperscalers.
Widespread enterprise adoption will be critical. While many companies are already incorporating AI tools, the central question is how quickly those efforts become transformative, producing measurable productivity gains or new revenue streams. If compelling use cases fail to emerge at scale, excess capacity could lead to intense competition, weak pricing power, and diminished profitability—echoing the dot-com experience.
Lessons worth repeating
The market’s journey in 2025 reinforced several enduring investment lessons. First, volatility is a normal feature of equity markets—even in strong years. It is the toll investors must pay for long-term returns, not a signal to abandon course. Consider the record: Over the past 45 years, the S&P 500 has experienced an average drop of about 14% within the course of the year yet finished with positive returns about three-quarters of the time. This year followed that familiar pattern: double-digit gains accompanied by sharp drawdowns and multiple sentiment swings.
Second, markets tend to process political headlines relatively quickly and move on to refocus on fundamentals. This year, trade disputes, fiscal debates, and political divisions dominated the news cycle and caused short-term lurches, but earnings growth, interest rates, and capital flows ultimately determined the destination.
Finally, 2025 underscored how costly emotional reactions can be. Knee-jerk responses to unsettling headlines often lock in losses and miss out on subsequent recoveries. Investors who exited earlier in the year—whether in response to the initial political rhetoric or after the market struggled—missed a powerful rally fueled by strong corporate earnings and easier monetary policy.
Staying on the rails
Looking ahead to 2026, the backdrop remains noisy but still appears broadly supportive for equities. Absent a renewed pickup in inflation, the Federal Reserve should be able to continue easing monetary policy, lowering short-term rates. Additional fiscal measures—through tax relief for consumers and incentives for business investment—should provide further support. Combined with ongoing AI-related investment, these forces offer a cushion for economic growth, even as a soft labor market bears watching.
An expanding economy would be a tailwind for corporate profits. Analysts currently expect S&P 500 earnings to grow at a double-digit pace in 2026. That said, the market has become increasingly top-heavy: The “Magnificent Seven” now account for more than one-third of the index’s market value and an even larger share of recent returns. With valuations elevated and scrutiny rising, the next leg of the market’s journey is likely to require broader participation. Continued progress may depend less on a handful of Big Tech leaders and more on the group of 493 pulling their weight.
– Christopher J. Singleton, CFA®, Managing Director
January 14, 2026