The Year of Uncertainty

by: Kenneth J. Entenmann CFA®, January 2, 2026

2025 was the year of uncertainty and a few dominant themes led a volatile economic year. Those themes were Artificial Intelligence (AI), tariffs, immigration and employment, tax policy, and regulatory policy. Given the uncertainty surrounding these themes, businesses entered 2025 in an extremely cautious mood. Businesses effectively called a corporate “time out” in the first half of 2025 as they assessed the uncertainty. Business investment and labor hiring slowed. This led to a lackluster economic start to 2025, with first quarter GDP posting a -.6%, the first negative growth since the second quarter of 2022. However, the economy recovered for the rest of the year, growing 3.8% and 4.3% in the 2nd and 3rd quarters respectively. The labor market continued to modestly decline throughout the balance of the year, with the unemployment rate rising from 3.8% to 4.6%. Inflation improved modestly but remained “sticky.” The combination of a slowing labor market and flat-lining inflation allowed the Federal Reserve Bank to resume its monetary easing policy, cutting rates three times since September. Given the vast uncertainty at the beginning of the year, the economic performance of the U.S. economy in 2025 was quite remarkable. The record shows accelerating GDP growth, a solid albeit slowing labor market, modest inflation, lower interest rates and record level equity markets. Not bad for a year of uncertainty.

Looking ahead to 2026, the themes that dominated 2025 remain, but many are more certain. While some of the uncertainty continues (forecasting is NOT an exact science!), there are reasons for optimism in 2026.

One of the most prominent reasons for optimism is the rapid advancement of AI. The prospects of AI have been driving economic activity and the equity markets. As AI develops, it is becoming clearer that it will have a material impact on productivity throughout the economy. Productivity is already improving. It is the economic gift that keeps on giving. Doing more with less allows businesses to increase product offerings, reduce costs and explore new markets. Clearly, massive capital expenditures on AI programming and AI infrastructure will help to stimulate the economy in 2026. This spending has catapulted U.S. equity markets to record high levels and valuations. Indeed, the S&P 500 Index is on track for its third consecutive year of double-digit returns! In turn, the “wealth effect” of higher equity markets helps fuel consumer spending, the primary driver of the U.S. economy. It is likely that AI’s influence on the economy will be increasingly more impactful.

The most controversial economic driver in 2025 was tariff policy. Indeed, tariffs are mainly responsible for the huge swings in GDP growth in the first half of 2025. “Liberation Day”, April 2, 2025, marked the start of the Trump Administration’s tariff policy. At the start, Liberation Day was a catalyst for a serious market correction, as the S&P 500 plunged by nearly 20% over the course of 6 weeks, ending April 8. The negative .6% first quarter GDP was largely the result of import dependent businesses front running the tariff implementation. Similarly, second quarter GDP of 3.8% was simply a reversal of the impact. Many economists forecast a significant increase in inflation. However, tariff policy began to morph almost as soon as it was announced. Initial start dates were delayed as countries began to negotiate new trade agreements. And then they were delayed repeatedly. Several new trade deals were consummated, reducing the overall impact of tariffs. Recently, tariffs on certain food items like bananas and coffee were withdrawn. Overall, the greatest fears of tariff policy failed to materialize. To be clear, some industries were impacted more than others; small businesses were hurt far more than large companies. Small companies simply do not have the pricing power and vendor control that large companies do. Despite all the vitriol, angst and uncertainty surrounding tariffs, their impact on the economy was modest. GDP was modestly lower, and inflation was modestly higher by about .5%. Not a great outcome, but not the predicted catastrophe. Regardless of how one feels about tariffs, the good news is their impact on inflation should diminish in 2026. Historically, tariffs have a onetime impact on inflation. As we approach the 1-year anniversary, the impact should decline. In addition, it is likely that more tariffs will be rescinded in 2026 as new agreements are finalized. In short, the negative karma associated with tariffs should diminish in 2026.

The labor market, inflation and interest rates were a huge source of uncertainty in 2025. The Federal Reserve Bank (the Fed) was/is struggling with these same factors. The Fed has a dual mandate: maximize employment and preserve price stability, i.e., control inflation. This sticks the Fed between a rock and a hard place. On one hand, the employment market slowed in 2025. November unemployment posted a 4.6% rate. Companies continue to reconcile the huge post-COVID hiring and the following hoarding of labor, particularly in the Technology sector. Immigration policy has reduced the size of the available labor force. There is a fear that AI will crimp employment. Nonetheless, small businesses, as noted in the survey, continue to find it difficult to find qualified workers. In short, the labor market is in a “low fire-low hire mode.” At a 4.6% unemployment rate, the labor market remains in decent shape.

On the other hand, inflation remains a concern for business and the Fed. As noted above, tariffs are a big part of this concern but should have a diminishing impact. The Consumer Price Index (CPI) has improved from its June 2022 peak of 9.2%. Yet, throughout 2025, CPI stalled at a “sticky” range between 2.8-3.1%. November CPI showed encouraging progress, coming in at 2.7%. Still, the Fed remains in a tough spot. Does the Fed lower interest rates further to stimulate a slowing labor market or maintain them to protect against inflation? The Fed has already opted in favor of its employment mandate, lowering rates three times in the fourth quarter of 2025. Entering 2026, the effective Fed Funds rate is 3.5%-3.75%, down from a peak of 5.5%. However, businesses should manage their expectations for further improvements in interest rates. Indeed, the Fed’s December meeting vote demonstrates the Fed’s dilemma. Dissents on Fed policy votes are highly unusual. At the last meeting, there were three dissents! One member wanted a .50% rate cut, while two members wanted to keep rates unchanged. Yes, it is unclear whether interest rates will continue to decline in 2026, but the good news is rates are unlikely to go up. The recent lowering of interest rates should provide stimulus to the overall economy in 2026.

Businesses will enter 2026 with tax certainty. Regardless of how one feels about the “big, beautiful bill” that became law in July 2025, it did provide tax certainty for business. The Corporate tax rate remained at 21%. Full expense of capital expenditure and favorable tax treatment for long-term fixed investment were codified. All told, this law provides meaningful incentives to invest. In addition, the recent passage of National Defense Authorization Act will generate $900 billion in defense spending which should provide a significant boost to the economy. Lastly, efforts to decrease regulation, particularly as it relates to the labyrinth of the permitting process, should also help to stimulate the economy. 2025 was a year filled with announcements of plans to build tech infrastructure and manufacturing plants across the country. Hopefully, with tax certainty and regulatory relief, 2026 will be the year where the shovels hit the ground!

The 2025 year-end tallies for the equity and fixed income markets demonstrate remarkable resiliency in the year of uncertainty. Looking into 2026, our long-held mantra to investors to manage their expectations seems appropriate. The aggregate bond index is up nearly 7% as we approach year-end. The strong return reflects the Fed’s rate cutting program. However, given the recent reluctance of the Fed to cut rates further, 2025’s strong performance will be difficult to replicate. Indeed, the 10-year return for the index is only 1.96%! It is a “be careful with what you ask!” situation. If bonds are to post another year of robust performance, it would likely require a significantly weak labor market or a recession that forces the Fed to cut rates more aggressively than the current market probabilities.

The equity markets are set to post their third consecutive year of double digit returns with year-to-date return of 17.41%! Not bad for a year of uncertainty! It is the third consecutive year of double-digit performance (2023 +26.29%, 2024 25.02%); that is a three-year cumulative return of 87% and an annualized compound return of 23.36%. Outstanding! Could the S&P go up double-digits for four consecutive years? It went up double-digit for five consecutive years from 1995 through 1999. So, it is certainly possible; but we should remember what followed! Once again, one should manage their expectations. The market remains highly concentrated, driven by the AI focused technology sector. The fact that the overall market is up 17% while the median stock in the index is up only 7% demonstrates this concentration. More concerning, the market remains highly valued on a historical basis. The price/earnings ratio of the S&P 500, based on a 2026 annual earnings estimate of $296, is 23 times earnings. The historic average is 17. This does not mean the market cannot continue to rise, but it will become increasingly difficult. There are basically two ways equities can maintain these lofty valuations. First, earnings need to exceed expectations. Second, interest rates need to be lower. In 2025, both happened! Can it happen again in 2026? Companies have demonstrated remarkably ability to increase earnings and the potential for AI to help continue this trend is real. However, the likelihood that equity market valuations will be supported by a significant reduction in interest rates as they were in 2024-2025 is small. Are double-digit equity returns possible in 2026? Sure, it is possible, but valuations and interest rate policy will remain a head wind in 2026.

As we enter 2026, there are reasons for optimism. AI continues to grow and looks to provide significant productivity enhancements. AI capital expenditures are gigantic and should increase construction spending and employment. Tariffs should have a diminishing impact. The labor market appears to be stabilizing, in a ”low fire-low hire” mode. Inflation is beginning to cool. The Fed has already begun to ease monetary policy, and the lower rates produced in the fourth quarter should provide stimulus in 2026. Tax policy is certain. Tax refunds in the first quarter of 2026 are estimated to be $150 billion which will fuel consumer spending. The headwinds of uncertainty in 2025 are ebbing, and many of those factors will now become tailwinds for economic growth. Indeed, reason for optimism in 2026.

Happy New Year!