The simple AI-generated image above captures our view of the current environment. AI is driving the stock market, and the stock market is driving unprecedented wealth effects which are supporting the economy. In 2025, each of these factors further positively reinforced one another. In the fourth quarter, there was some evidence of a more discerning investment environment. The backdrop was a good one for all our Decathlon portfolios, with each performing better than its expected asset allocation benchmark in the quarter. Although past performance is no guarantee of future results, it was encouraging to see strong performance in the final quarter of the year and many of the same trends have continued or accelerated into the new year.
Perhaps unexpectedly, 2025 marked the end of a long-running reign of U.S. stock market outperformance. International equities had their best relative performance since 2009, with the MSCI ACWI ex-U.S. Index returning over 30% versus the already strong 17% supplied by the S&P 500. Our highest risk growth portfolio ended the year with performance near that of U.S. equity markets, despite scant exposure to the prevailing U.S. growth and AI themes. The portfolio benefited from the strong performance of international equities and capitalized on opportunities in riskier areas of the market. While the lower risk strategies were later to the game on international exposure, they have jumped on board in recent months.
There were meaningful benefits to tactical asset allocation for the first time in at least a few years. While all strategies were generally at or above their expected equity exposures throughout the year, they generally held lower-beta equities. This generally conservative posture helped us weather the tariff-driven equity market drawdown in April, and our higher risk portfolios were able to add risk at an opportune time.
However, during the second half of the year it was difficult for our lower risk portfolios to keep up, in large part because of the anomalously poor returns from relatively lower risk parts of the market. The moderate and conservative strategies underperformed their expected asset allocations on the year achieving a high-single-digit and mid-single-digit return, respectively. Historically speaking, eschewing the most volatile equities has been a winning investment strategy, often even in strong markets and especially when adjusting for risk. In 2025, it was nearly the exact opposite. While the S&P 500 Equal Weighted Index, representing the average stock, underperformed the S&P 500 by over 6% in 2025, the S&P 500 Low Volatility Index underperformed by 14% and S&P 500 High Beta Index nearly doubled the market’s performance.
The performance differential between high and low-beta equities has historically mean-reverted, which implies we might see a resurgence in low-beta stocks in 2026. It is likely the S&P 500 itself has effectively become “high beta”, due to its increasing concentration over the past few years, perhaps similar to what occurred during the late 90s tech bubble.
As we find ourselves repeating many of the same themes of the last few years, it can be easy to assume very little might change in 2026. With that in mind, we’d like to rehash our opinions from this time last year and examine how the year played out. While many of the same stories remain front of mind, under the surface, 2025 was more eventful than it feels in hindsight, and we should expect nothing less from 2026.
However, during the second half of the year it was difficult for our lower risk portfolios to keep up, in large part because of the anomalously poor returns from relatively lower risk parts of the market. The moderate and conservative strategies underperformed their expected asset allocations on the year achieving a high-single-digit and mid-single-digit return, respectively. Historically speaking, eschewing the most volatile equities has been a winning investment strategy, often even in strong markets and especially when adjusting for risk. In 2025, it was nearly the exact opposite. While the S&P 500 Equal Weighted Index, representing the average stock, underperformed the S&P 500 by over 6% in 2025, the S&P 500 Low Volatility Index underperformed by 14% and S&P 500 High Beta Index nearly doubled the market’s performance.
The performance differential between high and low-beta equities has historically mean-reverted, which implies we might see a resurgence in low-beta stocks in 2026. It is likely the S&P 500 itself has effectively become “high beta”, due to its increasing concentration over the past few years, perhaps similar to what occurred during the late 90s tech bubble.
As we find ourselves repeating many of the same themes of the last few years, it can be easy to assume very little might change in 2026. With that in mind, we’d like to rehash our opinions from this time last year and examine how the year played out. While many of the same stories remain front of mind, under the surface, 2025 was more eventful than it feels in hindsight, and we should expect nothing less from 2026.
While many of our expectations for 2025 did not play out exactly as planned or perhaps more stubbornly have not played out yet, we did see some general discernment in the fourth quarter that makes us believe we will have a less straightforward risk-rewarded market in 2026.
As we spelled out in our last quarterly letter, we continue to view the fates of the market and economy as increasingly intertwined. This means, in our view, the biggest risk to the economy in 2026 is the stock market. While the economy appears to be weakening on the margin and inflation is a bit sticky, economic conditions at a macro level are not yet worrisome. It appears as though the wealthy can continue to drive consumption for the time being. At the end of 2025, equities constituted a higher percentage of individual net worth than Real Estate. The only other time this happened in history was 1999.
The tenuous relationship between Labor and Inflation will continue to be front and center in 2026 now that the Federal Reserve has continued its easing cycle and may soon be under new leadership. By their own admission it isn’t clear or obvious which part of the economy, Labor (theoretically benefitting from lower rates) or Inflation (theoretically requiring higher rates to “tame”), should be prioritized. While it is by no means a rule and may simply reflect hindsight bias, it is hard to ignore that when the unemployment rate begins to rise it has nearly always resulted in a recession in a relatively short period of time.
AI ROI
A major theme for 2026 is one that is likely to cause issues for the phonetically challenged – AI ROI (say that 5 times fast). We’ve been consistently skeptical of the potential returns and feasibility around the massive capital announcements we saw throughout the year related to AI despite being generally positive on the technology itself. In a rather short period of time, the market seems to have come around to our view of the potentially poor economics of the Oracle data center build out, with Oracle stock now trading below its price prior to the announcement. Investors are beginning to punish “AI” related stocks where the return on their massive capital outlays has come into question. We view this development as very healthy for markets but expect it will create significant volatility in 2026.
Still “betting on a broadening”?
We have long bemoaned the lack of consistent breadth in markets as a small subset of giant companies have driven a huge portion of index returns. The title of this section is a callback to our Q2 2024 Quarterly commentary. At the time, we saw our strategies move to interest rate sensitive, smaller cap sectors after consistently holding large-cap growth and tech for much of the prior year. Investors did indeed bid up financials and smaller-cap companies over the ensuing months on the prospect of rate cuts, and while similar behavior has occurred in short spurts since, it is hard to see where smaller-cap companies have consistently benefited.
The largest, dominant AI-themed businesses have outperformed substantially in both years. While we have been hopeful that market breadth would increase materially, we don’t believe that lower rates will be the catalyst for this. Although it isn’t something we see on the horizon, we believe it is possible all the profligate spending amongst the AI giants and their suppliers may create substantial overcapacity, the benefit of which will accrue broadly in the economy. In an ironic twist of fate, one day the broadening of economic and market performance might be directly driven by the actions of the current market behemoths.
While it may be a special circumstance, there was a recent example of a smaller business seeing a big benefit from modern AI. During its third quarter earnings call, Freight logistics broker CH Robinson materially boosted expectations for its own business based on leveraging large language models (specifically AI agents) for large scale automation. While just one anecdotal example, CH Robinson may have seen its own profits increase by more than the entire profits the AI model-building industry thus far. We expect widespread improvements such as this to be generally a bit further off, but they could ultimately create an environment where the few do not lead the many.
Playing It Safe Didn’t Pay
Surprisingly, the S&P 500’s sharp drawdown in April wasn’t the biggest challenge of the year. Our models handled the pullback well from a tactical standpoint, generally entering April underweight risk and increasing exposure near the market’s trough. By far the largest difficulty our models faced was the historically poor performance of lower-beta equities.
Throughout history, low-beta equities and high beta equities have each had a relatively consistent relationship to the S&P 500, but 2025 looks like a major anomaly for low-beta. The most recent historical parallel, which is similar in some ways and not others, is the tech bubble and subsequent fallout when investors dumped safe assets to buy technology companies, only to reverse course as the bubble burst.
International Economies Follow Through in 2026
Over the course of the last year, we have laid out the various rationale for the strong performance of international assets. In short, the combination of a weak dollar and controlled inflation in emerging markets and the prospect of strong fiscal support and re-accelerating low-growth economies in the developed world should provide a boost to these assets. While that is a powerful story, it will require actual results for the trend to continue and reverse years of U.S. outperformance. It’s still early, but the results are beginning to show, and we expect more investors to allocate to international equities in 2026 as they further notice the momentum. This remains a dominant investment theme across our strategies.
New Themes in the portfolio: Biotech, Clean Energy, and Japan
From a quantitative perspective two of the new themes we’ve seen emerge in our rankings can be classified as long-term underperformers with recent strong momentum: Biotech and Clean energy; while the other looks more like well-behaved momentum: Japan.
Each of the former might be viewed as “high-potential” investments, historically volatile sectors which appear to be overlooked or perhaps have new tailwinds emerging.
For Biotech companies, AI has the potential to accelerate research that leads to drug development but, until recently, they have not participated in investor excitement around AI. In the near term, they stand to benefit substantially from an increase in M&A activity as smaller biotech companies are often gobbled up by their larger cash-rich peers. The prospect of lower rates and increased capital markets activity should provide a tailwind for the sector.
Perhaps paradoxically clean energy underperformed during a “greener” administration, which allowed supply to increase substantially. The current administration’s hostility to green projects may ironically improve the economics for the existing clean energy in place. This sector is also highly international and could stand to benefit from the improved outlook overseas.
Japan is in the midst of a corporate transformation as regulators look to force companies to be more shareholder friendly. Historically, Japanese companies held excess cash and often un-related investments on their balance sheets. This type of behavior dampens would have certainly drawn the ire of activist investors pursuing change in the more financialized U.S. capital markets. In this case the activist appears to be Japanese regulators, and the market has performed well over the past few years as a result, yet it appears to have further room for improvement still.
Closing Thoughts
Risk-taking has been highly rewarded as of late, which can make investors complacent. Although strong market performance alone is not cause for concern, anomalously strong market performance has historically yielded sub-par intermediate results. What ultimately stops the music is often impossible to determine in advance, but so far there’s never been a party that didn’t end.
As the world becomes more interconnected, standing out is increasingly rare. We believe this is true in portfolios as well, particularly those of U.S. investors. Through sheer inertia, most portfolios are tilted towards U.S. growth stocks. In society and in markets we believe this will make the value of being different greater than ever going forward. We currently offer investors a unique portfolio. Our differentiated investment process, unmoored from many of the restraints of traditional asset managers, allows us to both move with the herd and stand apart from it.
Thank you for your trust in us and we hope you all have a wonderful and prosperous 2026!
Authored by Brendan Ryan, CFA
Originally published on Algorithmic Investment Models
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