“The time to do lifeboat drills is not after the ship has struck an iceberg.” – Nick Murray
The year in review
I’m happy to report on another successful year in the equity markets and in our plans for the pursuit of our clients’ most cherished financial goals. Our portfolio management efforts continue to be driven by these goals, rather than by any prognostication around the economy or the markets. That will always be the case throughout the coming year and beyond. As we kick off a new year, I’d like to start by offering a few comments about the economic/financial backdrop, and then I’ll repeat our annual advice to be careful not to be surprised by anything that happens in the financial markets this year.
In 2025, the broad equity market completed its third straight year of double-digit returns, driven by a strong economy and significantly increased corporate earnings. The S&P 500 ended the year up 16.4%. Looking forward to the new year, the consensus of analysts’ forecasts is for even stronger earnings gains, approaching 15% in each of 2026 and 2027, according to Yardeni research.
In our view, the strong performance of equities in 2025 was at least partially caused by the amazing profitability and productivity of the American economy. Somewhat remarkably, profit margins have continued to expand to 13.1% in the third quarter of 2025, the highest in 15 years. One would have thought that the inflation in companies’ costs, colliding with a strained consumer’s resistance to price increases, would have been a significant headwind to corporate profits. So far, at least, one would have been quite wrong.
The single important weak spot has been the employment picture, which has continued to soften. However, even this has its significant bright side: strong economic growth combined with a sluggish employment situation means that per capita productivity has been rising strongly. Unemployment may have recently ticked up to 4.7%, but the other 95% plus of the American workforce is putting out a significantly increased volume of products and services per hour, which allows companies to raise wages without triggering inflation.
After six straight rate cuts, Federal Reserve monetary policy is 175 basis points looser than it was a year ago, even with sticky inflation, and the CPI is still pushing 3%. It seems more than reasonable to expect the lagged effects of all this monetary easing to begin showing up in 2026, in the form of further economic growth.
The middle class in particular is set to enjoy tax refunds this filing season, which have been variously estimated at around $150 billion, representing a half a percentage point increase in GDP. The main engines of this are a higher standard deduction and a temporary restoration of the SALT tax deduction cap to $40,000 from $10,000. This would seem to be a potentially meaningful near-term economic tailwind.
It would not surprise us in the least if much or most of the above optimistic data comes as news to you — except, of course, the part about the softening labor market, which the financial media has trumpeted to the skies. In our opinion, there’s a great lesson to be learned from this, which is that the economic/financial “news” we get tends to skew overwhelmingly negative by conscious design. The fact remains that a very strongly rising equity market may (and indeed should) have taken this data into account — and maybe then some.
As the equity market continued to climb in 2025, the burning question all year long was “Are we in an AI bubble?” This replaced the previous year’s burning question, “When and by how much will the Fed cut rates?”, which in turn replaced 2023’s “Will there be a recession?”. There was no recession, but that’s beside the point. The universal burning question is usually not only the wrong question, but it is also a distraction for the well-diversified long-term investor.
Having said that, there can be no question that the broad equity market is more heavily concentrated in a few huge tech stocks — which can’t all be going to win the AI race — than it’s ever been in our investing lifetimes. And that this concentration has the Index selling at valuations in the neighborhood of its historic peaks. Our response to this is twofold: (a) Valuation is not, never was, and never will be an effective market timing tool. And (b) this is why we diversify and rebalance client portfolios every year, to protect from over-concentration in any given sector.
All of this suggests to us that the next significant market shock will probably come out of deep left field, and will be an “unknown unknown,” as opposed to a “known unknown” like valuation or the national debt. Like all the shocks past, and all those yet to come, it will have very little to do with us, other than as a potential bargain-hunting exercise. We are following a plan that has always “worked” in the very long run, in that it has ultimately achieved the goals of investors like us. We do not accept that “this time is different,” regardless of what “this” may be at any given moment. And thus, we don’t adjust our strategy to accommodate the fads or fears of that moment.
A New Year’s resolution
January is the time of year we all make our resolutions for a better life in the coming year. As your investment advisors, we recommend that you adopt a resolution to become a better investor by not allowing surprise to creep into your investing strategy this year, because we have learned that “Surprise is the mother of panic.”
All good investing requires control of our emotions in the face of uncertainty about the future. There is an inverse relationship between the intensity of emotion that we may be experiencing at any given moment and our ability to think and act rationally. As our emotions crank up, our ability to act rationally begins to deteriorate. Emotion is the enemy of sound investing policy.
When fear and panic set in our minds, it is almost impossible to act rationally, and we are most susceptible to our worst and most regrettable investing mistakes. For evidence of this, we need to look no further than the millions of investors who liquidated their entire investment portfolios in the Fall of 2008 or March of 2020, in hopes of avoiding the global financial meltdown they were terrified was coming. Instead, as it turns out, those periods may have provided investors with the greatest buying opportunity of a generation, as stock prices plummeted far below their real intrinsic value.
So how can we engineer our investment philosophy in a way that avoids the possibility of panic?
A good place to start is by understanding what makes us experience panic. Fear does not necessarily spring from the news of some economic or geopolitical “crisis,” like higher interest rates or recession fears. Fear comes because we are surprised by these events; we are blindsided by a reality for which we were not prepared, and which causes us to lose our bearings. This surprise causes us to lose our ability to make sense of the world around us, and so we become fearful and uncertain about what will come next.
The best way to prevent fear and panic from sabotaging our investment program is thus to prevent ourselves from being surprised by events. In the simple wisdom of Nick Murray, we must do our lifeboat drills before the ship sails out of port.
The good news is that this resolution is relatively easy. The best way to avoid surprise is to understand the possibility that our investments will experience volatility this year, as well as the severity of that possible volatility. In other words, we must vigilantly school ourselves in the history of markets, so that we can constantly remind ourselves of the difference between volatility (the normal incidence of temporary decline) and risk (the historically nonexistent chance of permanent loss) in our portfolio strategy.
So, as 2026 begins, let us resolve to understand the historical incidence of bear markets.
Bear markets
We define a “bear market” in the stock market as a more extended, steep (20% or more) decline in stock prices. Bear markets are the birthplace of full-blown panic and can test the emotions of even the most seasoned investors. They are so scary, because they almost always occur during a time when the whole world is convinced of some geopolitical or economic catastrophe which is certain to tear down the fabric of our lives and economy as we know it.
Bear markets usually last for a year or two before they burn out, and markets start to recover. In fact, the longest bear market since World War II came in 1946-1949, which took 36.5 months for the S&P 500 to travel from its peak to its trough. Fortunately, bear markets happen fairly infrequently and should be expected on average about every 5 years. In fact, the following is a recent history of bear markets in the post-war era through the end of 2025.
Please note that we include here a few episodes during which the S&P 500 declined by slightly less than 20%, simply because they felt like bear markets too. In addition, this chart does not include dividends in the S&P 500 return, which makes these bear markets appear worse than they really were. As a result, this chart brings the investor closer to the actual emotions experienced in real time when the bear actually strikes.
The takeaways from this chart are:
- Although there is no way to predict future market conditions, we should be prepared that equities may struggle this year. Although markets have experienced positive momentum recently, there is no telling when a bear market might attack.
- Historically, bear markets can cause temporary declines of 20% to 50% of equity capital, and the worst on this chart was down 57%. This is likely to happen again, and although we do not expect it to be this year, it could.
- However, during this period of 75 years, the stock market moved from 19.3 in May of 1946 to 6,847 by the end of 2025. The patient investor over this period returned over 354 times her money.
We must keep in mind that bear markets can happen at any time, and they can be painful. However, historically, these have always been temporary setbacks in the context of a long-term uptrend. Historically speaking, the declines are temporary, and the advances are permanent.
Empowered vs. victimized
Before we leave the topic of volatility, it is also important to point out a transformative insight that can be drawn from truly understanding this data. This can allow the investor to use market declines as opportunities to remain confident, while everyone else around us is screaming in terror and uncertainty.
When we understand and come to peace with this data, we can begin to embrace equity volatility as a positive phenomenon and the reason for the premium return from equities. The term “volatility” refers to the relatively large and unpredictable movements of the equity market, both above and below its permanent uptrend line. Equities can, and frequently are, up over 20% one year and down 20% the next, and vice versa. However, if we believe that the long-run returns of equities will approximate the past return, we begin to understand that these periods of downside volatility must likewise at some point be corrected by a period of upside volatility, greater than the long-term average of roughly 10% per year.
Volatility is the reason equity investors are rewarded over time with premium returns, if we have the emotional strength to live through it. For the wise and patient investor, it also provides a unique opportunity to accumulate more equities during a time when prices are temporarily depressed … kind of like a “big sale.”
Helping those you care about
During the last year, the patience and discipline of all long-term investors were tested. Sadly, those investors who succumbed to the panic of those scary first weeks of April made a regrettable investing mistake that will be quite difficult to recover.
You likely have a family member, friend, or colleague who did not fare well during this episode and might have benefited from the sort of advice you were receiving in our monthly content. Should that be the case, we would appreciate your introducing them to our team. We love working with you and would welcome the opportunity to offer the same level of planning and service to the people you care about.
We wish all our friends and clients a healthy, happy, and prosperous 2026. We’re always here to address your questions and concerns.
Join us on February 18th at the Shooting Lodge at the Philadelphia Country Club
Please join us for our next “Great Investors LIVE” event on February 18th and REGISTER HERE. Feel free to bring along a friend or family member! Enjoy cocktails and hors d’oeuvres while we give a brief talk summarizing our outlook on current events. There will be ample time for Q&A and discussion to address any additional questions you may have.