An Unappreciated and Healthy Reset

A Challenging 2025 Market Still Reaches New Highs

We’re definitely experiencing a less-than-loved market in 2025.  Persistent concerns over the health of the consumer, a stubborn level of inflation, and tariffs and policy uncertainty in general have made this particular market go into the category of underappreciated.  And yet the S&P 500 made a new all-time high on Dec 11^th and has a total return of 17.6% year-to-date.

AI Mania Fueled the Market Rally—Until It Didn’t

Now, there are concerns over the massive spend by the mega-cap tech companies on the AI buildout, which largely didn’t start to show up until late October.  From the tariff-fears driven sell-off low on April 8^th until late October the S&P 500 rose 39.2%, mostly on the rocket fuel that’s been the AI mania.  Indeed, in that same time span the iShares AI Innovation and Tech Active ETF (BAI) surged 95.4%.  95.4% in a little less than six months!  But since late October things have changed.

Since the October 29^th market high reached on the aforementioned AI mania theme, the market chopped sideways before reaching a new high on Dec 11^th.  But what’s telling and different is that it was accomplished without an AI/Tech-heavy influence.  A broadening out within the market has quietly been taking place.  We believe that’s a good sign for the overall health of the market as we close out the year and look to 2026.

Equal Weight Indexes and Small Caps Signal Broader Participation

Demonstrating this broadening out, the S&P 500 Equal Weight Index and the Russell 2000 have both also reached new all-time high levels in December.  They’re up 11.7% and 14.9% year-to-date, respectively, compared to the S&P 500’s 17.6%.  More importantly, since Oct 29^th they’re up 2.5% and 2% compared to the S&P 500’s -0.61%, while the AI ETF (BAI) is down by 10.5%.

Since Oct 29^th, in particular, we’re seeing pro-cyclical stocks outperform:  the Dow Jones Transports Index is up 13.1%, regional and large banks are up 12.2% and 12%, respectively, and air travel stocks are up 17.2% (JETS ETF).  Transports rallying ahead of the broad market is thought to be a leading indicator of an improving economy.  Banks are benefiting from a rate easing cycle, a steepening yield curve and a less antagonistic regulatory environment.  And U.S. airline passenger travel miles have generally been increasing in 2025.  The most recently available data from October 2025 showed domestic traffic up 6.5% year-over-year.  Holiday travel is projected to break records and overall demand is strong.

Sector Rotation Emerges, Led by Health Care and Financials

On a sector basis, we’ve seen the most significant shift in health care.  It’s been weak for nearly three years!  In 2023 and 2024, the health care sector was negatively impacted by COVID destocking and lower funding availability because of higher real rates.  In 2025, investor confidence was shaken by a less than favorable environment out of Washington (NIH budget cuts, tariffs, and drug pricing).  Putting some numbers to this will help.  From late December 2022 to late September 2025 health care rose 3.33% compared to the S&P 500’s 78.7% return.  Since late September of this year, it’s outperforming 15.6% to 3.8%.  This doesn’t mean that health care is set to outperform in 2026, but rather it adds to the narrative that there’s some rotation and broadening out going on within the market.  Also demonstrating this rotation is financials compared to info tech.  Since October 29^th, financials have rallied by 5.3% compared to info tech falling by 6.4%.  That’s 1170 bps of difference.

Small-Cap Valuations and the Outlook for 2026

Investors should also be aware that we’re in the third year of a very strong bull market.  The S&P 500 in 2023 and 2024 had total returns of 26.3% and 25%, respectively, and 2025 is at 17.6%.  The S&P 500 is currently trading at 25.6x forward earnings, not cheap.  The S&P 500 Equal Weight isn’t a bargain either at 20x compared to its three-year average of 18x.

I would also point out that small-cap stocks aren’t overly cheap either at 41.3x compared to the group’s three-year average of 31.2x.  It must be noted that many small-cap companies aren’t profitable (chart below), which elevates the calculated multiple, of course.  Within the financial media there’s been some touting of small-cap stocks for 2026 recently as investors look to anything but the AI mania names, but investors should be cautious.  So, since late October the broad market is experiencing a rotation.  Does this persist into the new year?  Time will tell.  But the market is clearly starting to question the valuations and the runup in some of the mega-cap tech stocks. The correction currently underway in the AI mania names can also be looked at as healthy in that it resets expectations and brings a more sober assessment to the outlook going forward.  But the idea that the AI buildout is complete and over is likely incorrect, so we continue to find good growth opportunities in the midst of this rotation.

Advisors Capital Management, LLC is an investment advisor registered with the United States Securities and Exchange Commission. Registration does not imply any degree of skill or training. All investing carries risk, including the potential for the loss of principal and past performance is no guarantee of future results. This content is for informational purposes only, can change at any time without notice, and is not investment advice or a recommendation to trade any security. Indices are not available for direct investment. We only provide services in jurisdictions where we are registered. Our disclosure brochure (ADV Part 2A) and customer relationship summary (ADV Part 3) are available at https://adviserinfo.sec.gov and upon request.