Q4 2025

January 15, 2026

Throughout 2025, investors faced a steady drumbeat of concerns, including renewed tariff pressures, growing fiscal imbalances, persistent geopolitical tensions, and early signs of labor-market softening. Under those conditions, a cautious outcome would have seemed reasonable. Instead, the S&P 500 advanced 16%. That resilience reflected a convergence of supportive forces: corporate earnings held up better than expected, inflation continued to cool, and enthusiasm around artificial intelligence reshaped expectations for long-term productivity and growth. These dynamics pushed valuations to historically elevated levels after several years of strong returns, which has meaningfully altered the risk environment investors face today.

A helpful way to think about the current environment is the analogy of skating on thinner ice. When equity valuations are lower, markets have more “give”—they can absorb bad news or short-term disappointments with less volatility. When valuations are elevated, the margin for error shrinks, and even modest stressors can begin to expose cracks in the ice. Much of the good news—earnings optimism, lower rates, and AI-driven productivity gains—now appears to be priced in. As a result, future returns increasingly depend on things going right and staying right. In this environment, volatility can rise, leadership can narrow, and markets may become more sensitive to developments that would have been shrugged off earlier in the cycle.

Mohamed El-Erian, Chief Economic Advisor at Allianz, has cautioned that markets are vulnerable not because investors are blind to risks, but because they are overly confident in a narrow set of outcomes. As he has put it, markets are “pricing perfection in an imperfect world,” leaving them exposed to shocks that do not fit neatly into consensus forecasts. We have already seen early signs of this dynamic, with stress points emerging around Venezuela and oil markets, Federal Reserve independence, and renewed tensions involving Iran. These developments remind us that cracks can form even when overall sentiment remains optimistic. More importantly, the greatest vulnerabilities often lie not in the risks we can identify, but in those that have yet to surface—the second- and third-order effects that are not currently being discussed or priced.

Artificial intelligence offers a useful case study. There is little doubt AI is transformative and likely to reshape productivity over time. At the same time, the current phase of the cycle is extraordinarily capital intensive. Many AI-related companies have begun borrowing heavily to fund record levels of investment in data centers, power, and compute capacity. History suggests that periods of debt-funded investment can introduce fragilities if returns take longer to materialize or competition erodes margins. Markets have often conflated long-term potential with near-term profitability—a dynamic that has proven costly in prior cycles.

None of this argues for meaningfully altering asset allocations or retreating to the sidelines. Rather, it argues for discipline. Our approach continues to emphasize quality, cash-flow durability, and diversification across assets—staying closer to the shore, where the ice is thicker and more reliable, rather than venturing too far into the uncertain middle of the lake. We remain mindful that leadership can rotate quickly when expectations are stretched, and we focus on areas of the market where valuations are less prohibitive and returns are less dependent on perfect execution. In El-Erian’s words, the goal is to “be robust, not brittle”—to recognize that unanticipated risks are a feature of markets, not a flaw, and to prepare accordingly.

Sincerely,

Janet Wills

Adam Mehrer