GDP misses expectations, but it's not all bad

The advance estimate for Q4 2025 GDP showed the U.S. economy grew at just 1.4% annualized, well below the roughly 3.0% consensus expectation heading into the release. The slowdown was pronounced relative to Q3’s 4.4% pace, confirming that growth cooled materially into year-end. The deceleration was driven primarily by weaker government spending and softer net exports, while consumer spending remained positive but moderated. For full-year 2025, real GDP growth came in at approximately 2.2%, down from the stronger pace seen in 2024.

• The miss was almost all driven by the government shutdown at the end of the year
• That said, personal consumption (consumer spending) was +2.4% versus +3.5% in the prior quarter
• Importantly, the PCE price index (an inflation reading) was +2.9%, uncomfortably higher than the Fed’s 2% target
• Most analysts expect GDP to re-accelerate in Q1 2026 as the shutdown effects reverse
• We are also convinced that the Trump administration will maintain stimulative economic policies leading into the midterms

Trump’s tariffs struck down

This week, the US Supreme Court struck down a key tariff measure tied to executive trade authority, creating immediate uncertainty around the administration’s trade posture. Markets initially reacted favorably, viewing the ruling as disinflationary and supportive of global trade flows. However, the broader takeaway is policy volatility: trade, fiscal, and industrial policy remain fluid. Corporations that adjusted supply chains over the past several years now face another potential pivot. The ruling may dampen inflation expectations at the margin, but it underscores how political risk remains embedded in the macro backdrop.

• The Trump administration seems to have been caught off-guard by the ruling
• In response, the President announced that he would be maintaining tariffs using a different legal framework
• It isn’t clear if this is feasible, and it also isn't clear what is to be done about the tariffs already collected and the foreign investment that was tied to trade deals
• The positive market reaction was a bit surprising given the new additional uncertainties
• As it pertains to the tariffs already collected, this will likely go back to the courts for a drawn-out legal battle

Massive divergence in stock sector performance

The chart below tells the story of 2026 so far. Energy (XLE +22.65%) and Materials (XLB +16.82%) are decisively leading the market, followed by Industrials (XLI +14.24%) and Consumer Staples (XLP +13.08%). Utilities are up 8.54%, while the broader S&P 500 is barely positive at +0.88%. Meanwhile, Technology (XLK -2.32%), Financials (XLF -4.39%), and the NASDAQ 100 (NDX -0.98%) are negative year-to-date. This is not a risk-on growth rally — it is a rotation into hard assets, cyclicals tied to fiscal/industrial policy, and defensive cash-flow sectors. Leadership has clearly shifted away from the AI-driven mega-cap trade that defined prior years.

• While we have seen sector rotations several times in the past, this seems a bit different
• The AI narrative is shifting to the fact that the bottleneck seems to be the energy and materials needed to power the data centers that make this technology possible
• In addition, small-cap stocks have outperformed large-cap stocks
• This speaks to a general broadening of the stock rally that we have been in since the late 2022 lows
• This also indicates that passive broad index investing may lead to lackluster returns similar to the decade between 2000 and 2010

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