Table of Contents
The year 2025 feels like it flew by, leaving investors to process what many describe as a bizarre market year. Yet beneath the surface volatility and daily noise, familiar patterns emerged—and perhaps more importantly, familiar misconceptions about risk, opportunity, and where the economy actually stands heading into 2026.
Key Takeaways
- Despite feeling chaotic, 2025's 19% drawdown and 17% return looked remarkably similar to most market years when viewed historically
- The biggest perceived risk for 2026—according to 57% of Deutsche Bank survey respondents—is a tech valuation collapse as AI enthusiasm wanes
- Small and mid-cap stocks trade at historically attractive valuations relative to large caps, potentially setting up a coiled spring scenario
- Record cash balances (98th percentile historically) suggest significant dry powder remains on the sidelines
- The economy continues robust growth at 4.3% in Q3, yet remains the most hated economic expansion in memory
The Illusion of Market Chaos
Market participants love to declare each year uniquely volatile or strange. This year felt no different, with dramatic swings and headline-grabbing events creating the impression of unprecedented chaos. However, data from Ritholtz Wealth Management's exhibit charts reveals a different story entirely.
The 2025 market delivered a maximum drawdown of 19% alongside annual returns of 17%—figures that blend seamlessly with virtually every other year when plotted historically. Most years in the stock market are crazy. The perception of uniqueness reflects our tendency to experience each moment intensely while forgetting that volatility remains the market's natural state.
Individual Stock Performance Tells a Different Story
While broad indices appeared normal, individual stock performance painted a more dynamic picture. More stocks doubled in 2025 than in any year since 2013. This matters because 2017—often remembered as a year of steady, straight-line gains—saw only three stocks double despite minimal drawdowns. Even 2021's mania produced just twelve doubled stocks.
The thirteen doubled stocks in 2025 suggest significant dispersion beneath index-level calm, rewarding stock pickers while punishing others.
The 2026 Risk Everyone Sees Coming
Deutsche Bank's survey revealed that 57% of respondents consider tech valuations and waning AI enthusiasm the biggest risk to market stability in 2026. This overwhelming consensus raises an important question: if everybody's worried about it, will it actually happen?
Usually, the biggest risks blindside markets rather than appearing in surveys months in advance. Sometimes the most obvious threat materializes, but widespread awareness often leads to positioning changes that mitigate the very risk everyone fears.
AI Skepticism Already Emerging
Market pushback against AI investments has begun appearing. Oracle's stock reacted worse to its OpenAI partnership announcement than it did during the 2008 financial crisis. The Financial Times reported that Oracle's largest data center partner, Blue Owl Capital, declined to back a $10 billion facility deal due to rising concerns.
This skepticism creates what many consider an ideal setup heading into 2026. Markets work best when they climb walls of worry rather than scaling peaks of euphoria.
The Small Cap Opportunity
Bank of America data shows US mid-caps trading at 15 times forward earnings versus the S&P 500's 22 times multiple. This valuation gap has reached levels not seen since the mid-1990s, raising the question: are small and mid-caps the next international stocks?
International stocks spent years trading at discounted valuations before their recent outperformance. It didn't take much good news for these coiled springs to release significant returns. Small and mid-cap stocks appear positioned similarly.
Multiple Catalysts Converging
Several factors could benefit smaller companies simultaneously. Lower interest rates would help these typically more leveraged businesses. AI adoption could provide operational advantages. Most importantly, if institutional money finally flows toward small caps, the combination creates a powerful triple catalyst—unusually generous conditions for any investment theme.
The Russell 2000 has already gained 46% since its April 8th bottom, yet flows remain minimal. This performance amid investor indifference suggests substantial upside if sentiment shifts.
Economic Reality Versus Perception
The US economy grew at 4.3% annualized in the third quarter—robust by any measure. Yet this expansion remains the most hated in memory, with widespread disbelief in official economic data.
The Inflation Psychology Problem
Wage growth has averaged 4.1% since April 2023 versus 2.9% pre-pandemic. This exceeds inflation consistently, yet psychological damage from 2021-2022's price surge persists. When polled about returning to 2019 wages for 2019 prices, even affluent audiences split 50-50—suggesting most people underestimate their real wage gains.
The relationship between wages and inflation validates official numbers. High inflation periods historically coincide with high wage growth; low inflation periods see modest wage increases. Current 4% wage growth alongside 3% inflation represents a favorable environment for workers.
Cash Hoarding at Record Levels
Perhaps the most striking disconnect involves cash holdings. Households hold near-record cash balances at the 98th percentile historically as a percentage of total financial assets. During a bull market, this seems counterintuitive.
This cash accumulation occurred despite massive gains in both stocks and real estate. The trend likely reflects a decade of zero interest rates creating structural under-allocation to cash, now being corrected as cash yields 5%. Whether this represents dry powder for future investment or permanent portfolio allocation changes remains unclear.
Technology's Deflationary Future
Looking ahead, artificial intelligence may represent the most powerful deflationary force in economic history. Critics predicting 1970s-style inflation may seem misguided in hindsight, having worried about persistent price pressures precisely when transformative productivity technology was emerging.
AI Adoption Still Early
Only 5% of people pay for AI chatbots currently, according to Benedict Evans' annual presentation. This low penetration rate, combined with the technology's obvious utility, suggests massive adoption potential remains.
The most deflationary technology in history was coming when people predicted 1970s-style inflation
Simple demonstrations of AI capability—like automatically cataloging and categorizing books from a photograph—reveal magical possibilities that remain largely unexplored commercially.
Looking Forward
The biggest risk for 2026 might not be the tech valuation collapse that 57% of survey respondents fear. Instead, it could be missing opportunities created by excessive pessimism about economic conditions, undervalued small caps, and transformative technologies still in early adoption phases.
Record cash balances, historically attractive small-cap valuations, and continued economic growth create conditions more favorable than sentiment suggests. While volatility will undoubtedly continue—as it always does—the foundation for continued market progress appears solid.
The challenge for investors will be separating signal from noise, focusing on fundamental developments rather than daily headlines, and maintaining perspective when others lose theirs. As always, the biggest risks may be the ones nobody sees coming, while the obvious dangers everyone discusses prove manageable.
