Fourth Quarter Review

Investors enjoyed positive returns in the fourth quarter with bonds up 0.9% and U.S. stocks moving higher by 2.4%, while those attempting to discern the health of the U.S. economy were left dealing with an extended data void due to the U.S. government shutdown that began at the start of the quarter.  With data now flowing again, third quarter gross domestic product (GDP) was reported at a level of 4.3% (higher than forecast), the unemployment rate has moved up to 4.6% (higher than forecast), and the Consumer Price Index (CPI) moved back below the 3.0% threshold registering 2.7% (lower than forecast). Numerous economic and market observers question the validity of these data points due to the disruption of data collection that occurred during the shutdown period. In numerous cases, these distortions will be addressed in reports released over the coming months.

Fourth quarter GDP is forecast to grow at a much more moderate rate of 1.0% with a resulting annual rate of 2.0% for all of 2025. A 2.0% annual reading would represent a meaningful reduction in growth from the prior two years where GDP registered increases of 2.9% and 2.8% for 2023 and 2024, respectively. A significant contributor to the slower growth in the fourth quarter is the negative impact resulting from the 43-day government shutdown.

2026 Economic Outlook

The U.S. economy is anticipated to grow at a rate of approximately 2.0% this year, virtually the same as 2025 with a current recession probability of 30%, according to the monthly survey of economists conducted by Bloomberg.

The U.S. consumer is forecast to maintain its status as a primary driver of economic growth. One of the drivers of the anticipated recovery in consumer spending are provisions of the One Big Beautiful Bill Act (OBBBA) that will lead to increased refunds for many taxpayers. The increase in refunds will help to decrease the current magnitude of the current “K shaped” economy that exists in the U.S. that has seen those citizens with higher compensation and/or extensive stock market and real estate holdings faring materially better than those with lower incomes and less substantial holdings in equities or real estate. In quantitative terms, consumer spending is expected to register growth at a slower pace of 1.2% for the fourth quarter and then rebound to 1.9% growth in the first half of 2026.

Another key benefit derived from the OBBBA is that businesses will be able to deduct capital expenses at a faster pace for items such as research, development and equipment. In combination, all the various facets of the OBBBA translate into an additional 0.9% of real GDP growth this year, according to the Congressional Budget Office.

Despite our outlook for positive economic growth, we readily acknowledge the numerous risks that could lead our outlook to fall short of expectation. One of these risks is the upcoming mid-term elections occurring later this year which could meaningfully change the course of fiscal policy and slow the current momentum for deregulation. Another risk would be an unanticipated meaningful decline in AI-related capital expenditures as companies slow the pace of integration in an effort to assess the significance of AI’s impact on their financial performance.

One final risk to present is the potential consequence if the Federal Reserve becomes overly aggressive in cutting interest rates. Doing so could lead bond vigilantes to push long-term interest rates higher, increasing borrowing costs which become a drag on economic growth.

While we are certainly cognizant of the risks to our economic outlook, we will move forward utilizing our base case while continuously monitoring reported data and prospective extraneous developments that could lead to the need to adjust the outlook.

Asset Allocation

A Look Back at 2025: Strong Returns Across All Assets, Cautious Optimism for 2026

The past year was notable, with nearly every major asset class delivering above-average returns. Cash yielded over 4%, stocks surged by 17%, and bonds achieved a 7% return. The environment was shaped by a restrictive monetary policy for most of the year, which supported cash yields, while anticipated policy easing fueled the stock market rally. Strong credit fundamentals and falling interest rates drove bond price increases.

Our Asset Allocation Stance

Our asset allocation positioning has remained neutral, closely mirroring our strategic benchmark across cash, fixed income, and equity sectors. Our 12-month outlook process is designed to prevent reactive shifts based on short-term volatility, such as the U.S. stock market fluctuations observed in the second quarter of 2025.

Equity Positioning: Domestic versus International

We’re feeling cautiously optimistic about stocks, both here in the U.S. and abroad. Last year, international stocks were strong in part because the U.S. dollar was weakening. Now that the U.S. dollar’s value has leveled off, the currency play may not provide the same boost to foreign equities in 2026.

In 2025, investors were willing to pay a premium for stocks, essentially betting on strong future earnings growth. This year, companies actually need to deliver those profits to justify their high price tags. While we think U.S. companies are more likely to hit those earnings targets than their international counterparts, we’re not ready to apply an overweight on U.S. stocks just yet—there are still some prospective risks on the horizon as outlined in our lead article.

Small Cap Stocks: Potential Meets Skepticism

Large cap stocks maintained their dominance over small caps in the recent period, with returns of 17.4% for large caps versus 12.8% for small caps. Although analysts are projecting strong earnings growth for small cap stocks, some of the best in years, we remain cautious. Key challenges include a significant percentage (33%) of small cap firms lacking profit, concerns about the quality of year-over-year earnings, and potential dispersion in analyst estimates.

As a result, we are keeping a neutral weighting for small cap stocks, adopting a “show-me” stance regarding the expected earnings pickup. Within our Separately Managed Account (SMA) strategies, we are selectively exposing our small cap portfolios to specific areas where structural growth tailwinds strongly support upside.

Bonds Versus Stocks

Our outlook for bonds anticipates returns in line with the current average yield of 4.3%. Though this expected return is less than that of stocks, recent stability in bond price volatility provides a crucial balance against the risks highlighted in our economic and market article.

We will close with our standard recommendation for investors to use the quarter-end as a timely reminder to review their investment goals and objectives.

The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.

This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.