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International markets were mixed in the final quarter after far outpacing the domestic stock market on the back of a weakening Dollar for most of the year. The MSCI EAFE Index ends the year up over 30%, marking the widest margin of outperformance relative to the U.S. since 1993. Positive catalysts remain for many overseas developed and emerging markets, and while it’s unlikely that the US dollar will drop by the same magnitude as in 2025, continued dollar stress would be a tailwind for international assets.

Fixed income markets also posted solid gains for the year as an easing Federal Reserve (Fed), stable economic backdrop, and strong demand pushed intermediate (3-7 year) yields lower and corporate risk premiums (spreads) tighter. We saw a continued steepening of the yield curve in the final quarter of 2025 as short rates fell along with Fed cuts while the long end remained elevated given fiscal and inflation dynamics. The credit market is valued as if it will be smooth sailing into the foreseeable future, with spreads near all-time tight levels. Still, upper-single digit returns, and normalized yields reinforce the role bonds can play in a portfolio.

The turn-away from AI enthusiasm to end the year is noteworthy. As funding for AI-related projects spread into the debt markets, the excitement over its potential has also transitioned into concern over cost and sustainability. Whether investors see returns from the hundreds of billions of dollars of data center and infrastructure spending remains among the biggest questions heading into the new year.

Economic Stability

For now, the U.S. economy enters 2026 on firm footing. Tariff uncertainty, which dominated headlines for most of 2025 is fading to the background. The Fed has brought policy down 175 basis points so far this cycle. Fiscal policy is working as a tailwind, with broad-based incentives from the “One Big Beautiful Bill” still moving through the economy. Then there’s the mighty consumer, who continues to spend. And, with home-equity-line (HELOC) rates dropping alongside policy cuts, homeowners have the ability to unlock additional purchasing power. Lower oil and gasoline prices will also support spending. Nothing improves sentiment like lower fill-up costs.

And yet, there are enough question marks to give us pause. The employment picture is cloudy, with headline unemployment rising despite private hiring and small business hiring plans inflecting higher. That contradictory narrative is something the Fed will have to account for as it dictates policy in the months to come. The inflation outlook is also somewhat foggy. Stimulative fiscal and monetary policies, along with the impact of tariffs, will continue to put upward pressure on prices. For those keeping track, inflation has run above the Fed’s 2% target since March 2021. This, along with climbing deficits has kept the back end of the Treasury yield curve (and other borrowing instruments like mortgages and long corporate debt) firmly elevated.

Investors should expect the Fed to stay ambiguous until data (either inflation or employment) forces their hand. We continue to believe that the inflationary impulse is a bigger deal than the market is pricing in.

Outlook

The most encouraging trend in equities has been breadth. Small caps and value stocks, albeit temporarily, reversed a two-year stretch in which a small group of mega-cap growth companies carried the entire market. This broadening can continue if the economy remains resilient. Small and mid cap earnings growth has shifted upward to end the year. Growth at a reasonable price may increasingly be found beyond mega-cap growth stocks.

On the other side of the portfolio, fixed income finally contributes meaningfully to total returns. And absent a recession that would force rates much lower, we expect this theme to last as well.

We remain constructive, but not euphoric. A broader stock market is a healthier stock market. Bond yields should compensate investors with a return above inflation, and they finally do.

A stable economy, supported by resilient consumers and pro-growth policies presents a favorable launch point for 2026. Investors are afforded enough positive tailwinds to participate, and just enough uncertainty to stay disciplined in the new year.

This piece was authored by Patrick Ryan, CFA®, Chief Investment Strategist, Head of Multi-Asset Solutions, and Portfolio Manager for Madison Investments. He also serves as a member of the Investment Risk Oversight Committee and is a Madison Investments Foundation board member.