Q4 2025 Capital Markets Update: Strong Returns, High Valuations, and What Could Shape 2026

After three consecutive years of strong equity market performance, investors are entering 2026 with momentum—but also with important questions about valuations, earnings sustainability, interest rates, and the broader economy.

In LoVasco’s latest Capital Markets Review, Retirement Plan Consultants Jim Chapman and Chris Schuppe join Mike Iley to break down what’s driving markets today and what plan sponsors and fiduciaries should keep in mind as we move into the new year.

If you sponsor a retirement plan, oversee pension assets, or serve on an investment committee, this quarterly update provides timely context for evaluating portfolio strategy and participant outcomes heading into 2026.

Q4 2025 Capital Markets Review

Highlights and Takeaways

► Equity markets delivered another strong year, but returns are expected to moderate

The S&P 500 finished 2025 up approximately 18%, following gains of 24% in 2023 and 23% in 2024. After three exceptional years, expectations for 2026 are closer to long-term averages—around 10%, which would still represent healthy market performance. However, elevated valuations suggest markets may be more sensitive to earnings disappointments or policy shifts.

► Valuations remain elevated, largely driven by the “Magnificent Seven”

Forward price-to-earnings ratios for the S&P 500 are near 22x, levels last seen during the late-1990s tech bubble and the post-COVID rebound. Much of this valuation pressure comes from the Magnificent Seven, which now account for nearly 37% of the S&P 500—far higher than historical concentration levels.

When those seven stocks are removed, market valuations appear more reasonable, reinforcing that today’s “expensive market” narrative is largely concentrated in a small group of mega-cap growth companies.

► AI investment is real, and it’s being funded by corporate cash, not debt

One factor supporting higher valuations is the scale of corporate investment in artificial intelligence. Hyperscale technology firms are expected to spend hundreds of billions annually on AI infrastructure, with spending projected to exceed $600B by 2027.

Importantly, these investments are largely being funded through internal cash flows rather than heavy borrowing, signaling financial strength and long-term strategic commitment rather than speculative expansion.

► Growth stocks still lead, but value and small caps may regain relevance

Large-cap growth dominated returns in 2025, continuing a multi-year trend. However, mid-cap and small-cap stocks—particularly value-oriented names—benefited from easing interest rates, which tend to favor smaller companies that rely more heavily on borrowing for expansion.

With rate cuts expected to continue in 2026, diversification across size and style remains important, as leadership could broaden beyond mega-cap technology stocks.

► Labor markets are cooling, and consumer stress is rising

Unemployment has begun to tick higher, wage growth is slowing, and job openings have returned to pre-pandemic levels. At the same time, early-stage delinquencies on student loans, auto loans, and mortgages are rising—some exceeding pre-COVID levels.

These trends suggest the consumer may be under growing financial pressure, which could influence both economic growth and Federal Reserve policy decisions in the year ahead.

► The Fed is likely headed toward modest rate cuts in 2026

After cutting rates by 75 basis points in late 2025, the Federal Reserve is expected to make additional modest cuts in 2026, potentially bringing short-term rates closer to the 3% range by year-end.

As the yield curve normalizes, fixed-income investments may become more attractive—offering both income and potential price appreciation if rates continue to fall.

What This Means for Plan Sponsors and Fiduciaries

With markets near record highs and economic signals becoming more mixed, discipline remains critical. Sponsors should:

• Review investment menu diversification and concentration risk
• Evaluate the balance of active and passive strategies across asset classes
• Ensure fixed-income options align with changing rate dynamics
• Monitor participant behavior and financial stress indicators

Staying proactive—not reactive—remains the best way to support long-term participant success.

▶️ Watch the full Q4 2025 Capital Markets Review for deeper insight into where risks and opportunities may emerge in 2026.