Bloomberg Surveillance 12/31/2025

Key Concepts

• 2025 Market Performance: US equities and bonds experienced double-digit gains, while the dollar weakened, and commodities like gold and silver surged. Oil faced its worst year since 2020.
• 2026 Economic Outlook: The central question is whether global markets can outperform the US, with a focus on steepening yield curves, potential fiscal stimulus (particularly in Europe), and the sustainability of AI-driven growth.
• K-Shaped Economy: Divergent economic performance across sectors and income levels remains a key characteristic.
• Federal Reserve Policy: Rate cuts are anticipated in 2026, but the timing and extent are debated, balancing inflation and employment concerns.
• AI’s Impact & Risks: AI is driving tech gains, but concerns exist about the sustainability of returns if investments don’t deliver, and the concentration risk in credit markets.
• Labor Market Stability: The US labor market remains relatively stable, with low jobless claims, but a pickup in the hiring rate is needed for a more positive outlook.
• Travel Trends: Strong demand for premium travel options contrasts with declining inbound US travel.

Market Review & 2026 Outlook

2025 concluded with significant market movements: double-digit gains in US equities and bonds, the fastest dollar weakening since 2017, record highs for gold and silver (levels not seen since 1979), and a challenging year for oil (worst since 2020). Spanish stocks achieved their best year since 1993. Looking ahead to 2026, the key question is whether the rest of the world will outperform the United States. A steepening of yield curves globally, driven by inflation and government debt, is a central theme. The Bloomberg Global Aggregate Index saw the biggest yield curve steepening since 2016, with the two-year Treasury yield falling from 4.23% to 3.45% while the 30-year yield remained around 4.79%.

Economic Landscape & Policy Considerations

The economy exhibits characteristics of a “K-shaped” recovery, indicating divergent performance. Despite concerns about immigration and potential unemployment increases, panelists expressed optimism about continued economic strength, fueled by approximately $40-50 trillion in wealth created since 2019 and a Q3 GDP growth of 4.3% (potentially exceeding the Fed’s 1.9% estimate for 2026). The Federal Reserve is expected to cut rates in 2026, but the timing and extent are debated within the FOMC, prioritizing both employment and inflation control. The expiration of enhanced Affordable Care Act (ACA) subsidies could lead to premium increases for millions of Americans. Ray Dalio highlighted five major risks: debt cycles, political polarization, geopolitical shifts, natural disasters, and technological disruption (AI).

Investment Strategies & Sector Rotation

A potential rotation out of US equities and into European equities and cyclical/value stocks is suggested as a diversification strategy. European equities (SX5E) have outperformed all US indices in local terms and are approaching the performance of the “Magnificent 7.” Earnings growth is expected to broaden beyond the “Magnificent Seven,” with projections of 12-15% for 2026. A cyclical rotation into financials and industrials – particularly those tied to data center buildout and reshoring – is recommended. Small-cap performance is expected to be limited due to interest rates. The AI trade is expanding beyond semiconductors to include investments in data centers, electrical conductivity, and related infrastructure.

AI, Geopolitics & Credit Markets

The significant role of AI in driving the tech rally is being questioned, with concerns about the sustainability of returns if returns on invested capital don't materialize. Michael Purves argued that the tech rally is intertwined with the broader S&P 500 rally, but questioned the sustainability of valuations. NVIDIA’s acquisitions of AI 21 Labs and an Israeli company were cited as examples of frantic activity. AI-related issuance now accounts for 14% of total investment-grade issuance, up from 7% in 2024, raising concentration risk. Stabilizing rhetoric between the US and China presents opportunities in emerging markets, contingent on dollar stability tied to interest rates. Credit markets have performed well, with high-yield credit returning 8% and investment-grade credit over 9%, but spreads are tight, limiting potential alpha. The opacity of the private credit market is identified as a potential risk.

Labor Market & Data Dependency

Initial jobless claims came in at 199,000, below the expected 218,000, and continuing claims decreased to 1.806 million, indicating a relatively stable labor market. Jobless claims have remained within a narrow range since the end of 2021. While layoffs haven’t increased as much as anticipated, the hiring rate remains a concern. A 4% unemployment rate is cited as a potential trigger for earlier rate cuts. Upcoming economic data releases (ADP employment, JOLTS, ISM services, December payrolls) are crucial for assessing the labor market and influencing Fed policy.

Travel & Consumer Behavior

The airline industry is experiencing strong demand for premium travel options (Premium Economy & First Class), particularly on outbound international flights. However, inbound travel to the US has decreased. Customer satisfaction varies significantly between airlines, with Delta and United consistently outperforming American Airlines and Ev Air receiving criticism for prioritizing passenger density over comfort. Consumer spending is expected to be up 4-5% during the holiday season.

Conclusion

The closing of 2025 reveals a complex economic landscape poised for potential shifts in 2026. While the US experienced strong market gains, the focus is shifting towards global opportunities, particularly in Europe, and the sustainability of AI-driven growth. The Federal Reserve faces a delicate balancing act between controlling inflation and maintaining employment, while investors navigate a market characterized by tight credit spreads and concentration risk in the AI sector. A stable labor market and upcoming economic data will be critical in shaping the economic trajectory and influencing monetary policy decisions. Diversification and a careful assessment of risk are paramount in this evolving environment.