January 9, 2026

2025 in Review: A Year of Contrasts

2025 was a year of sharp contrasts. Economic growth slowed markedly, yet equity markets posted strong gains, propelled by extraordinary investment in Artificial Intelligence (AI) infrastructure. The period was marked by elevated volatility, driven by significant shifts in U.S. trade and fiscal policy, alongside the rapid advancement of transformative technologies.

AI-related capital expenditures emerged as the dominant market theme, with a small group of technology giants on track to collectively invest hundreds of billions of dollars in 2026.

Ongoing tariffs, military actions involving Iran, federal lawsuits, and a U.S. government shutdown all contributed to headline risk throughout the year.

Despite these challenges, the U.S. economy continued to expand, though persistent elevated inflation and a softening labor market led to a noticeable pullback in consumer spending. Encouraging developments emerged as the year progressed: a major tax and spending bill was passed, corporate earnings generally exceeded expectations, and the Federal Reserve lowered interest rates. While the technology sector drove much of the market advance, earnings growth broadened to other sectors later in the year.

Current market concentration in AI-related stocks has prompted comparisons to the late-1990s “dot-com” era and renewed debate about the possibility of a bubble. Our view is that these discussions reinforce the importance of disciplined risk management and meaningful diversification to enhance long-term portfolio resilience.

Fixed Income Review

2025 proved to be a strong year for fixed income, with positive returns across all segments. Investment-grade corporate bonds and municipal bonds outperformed U.S. Treasuries, supported by solid credit fundamentals and attractive relative valuations.

The Treasury yield curve largely normalized over the course of the year, leaving only a minor 10-basis-point inversion between the 6-month and 3-year maturities at year-end—a significant improvement from earlier in 2025.

Inflation finished the year at approximately 2.8%, above the Federal Reserve’s 2% target but sufficiently moderated to allow three federal funds rate cuts totaling 75 basis points. Market liquidity remained robust, with tight bid-ask spreads reflecting strong dealer confidence and a healthy, efficient marketplace.

Preferred securities were a standout performer in 2025, delivering among the highest total returns in fixed income, benefiting from both declining rates and strong financial-sector fundamentals.

Stock Portfolio Commentary

Large-Cap Strategy: Our large-cap approach continues to emphasize diversification and high-quality companies. The dominant AI investment theme has materially increased mega-cap weightings in both our models and benchmark indices. In the fourth quarter, we observed encouraging signs of market broadening as capital rotated into previously overlooked sectors.

The strong markets throughout the summer and early fall allowed us to trim back some of our largest overweight companies (Alphabet, Microsoft, Nvidia), while still maintaining each of their positions among the top holdings in our strategy. We’re encouraged by the ‘broadening out’ at the index level, and purchased an S&P 500 Equal Weight ETF, to gain exposure to the 493 companies who haven’t kept up with mega-cap tech. Looking forward for Large Cap, we’ll be keeping a watchful eye on valuation within the AI & technology dominant theme(s), while also seeking additional sector and company level diversification opportunities.

Small- and Mid-Cap Strategy: Performance in our small- and mid-cap strategy was disappointing for both the fourth quarter and the full year. Relative underperformance versus the Russell 2500 Growth and S&P MidCap indices primarily reflected limited exposure to high-momentum sub-sectors—such as bitcoin mining, quantum computing, gold mining, nuclear fuel, and drone manufacturing—that drove much of the benchmark gains. This positioning is a direct result of our long-standing valuation discipline, which avoids highly speculative names.

The portfolio was also pressured by weakness in several long-term core holdings that have historically performed well for us, as well as a sharp third-quarter decline in discretionary consumer spending.

The largest individual detractor was Fiserv, a leading technology provider that serves as the backbone for financial transactions across millions of consumers, businesses, and institutions. While its core franchise remains dominant, softer consumer spending in the second and third quarters led to market share losses in its Clover merchant payment processing unit and raised temporary concerns about execution.

We remain steadfast in our commitment to diversification, single-stock risk reduction, and quality. Speculation is not part of our process; we do not own unprofitable or low-quality companies, including those with negligible revenue, weak balance sheets, meme stocks, precious metals miners, or crypto-related names.

Outlook for 2026

Looking ahead, several themes are likely to shape the investment landscape. We expect the AI cycle to transition from infrastructure buildout to broader application across industries. Companies in industrials, healthcare, transportation, and beyond are already deploying AI to improve efficiency and reduce costs, setting the stage for potential long-term productivity gains.

Corporate earnings are forecast to grow meaningfully in 2026, with broadening participation beyond mega-cap technology names. This could reduce market reliance on a narrow set of leaders and create opportunities in lagged segments.

Interest rates will remain a key variable. With the Federal Reserve having resumed cuts and adopting a data-dependent posture, a modestly lower-rate environment could support both business investment and consumer activity. Recent tax legislation is also expected to provide an early-2026 tailwind, with refunds potentially offsetting lingering inflationary pressures.

In fixed income, uncertainties include the Federal Reserve’s leadership transition—the first new Chair in eight years—and ongoing geopolitical risks. Nonetheless, we remain constructive on the asset class overall and particularly positive on investment-grade preferred securities, which continue to offer attractive 5–6% yields, strong issuer fundamentals, and valuable diversification benefits.

Opportunities remain for disciplined patient investors across both equities and fixed income. We believe a focus on quality, thoughtful structure, and broad diversification will continue to be rewarded.

Thank you for your continued trust and partnership. We welcome the opportunity to discuss your portfolio, goals, or any market developments at your convenience.

Enjoy the remainder of your winter, and good health to you all!

The Team at Nicollet Investment Management