A Year of Divergence, Discipline, and Decisive Outcomes

2025 will be remembered as a year defined by divergence—between regions, between market capitalizations, and between expectations and outcomes. What began under the weight of uncertainty gradually evolved into a far more constructive environment as inflation moderated, central banks pivoted, and investors selectively re-embraced risk. While volatility surfaced at various points throughout the year, markets ultimately rewarded discipline and patience, particularly in areas that had been previously overlooked.

Canada and the United States followed distinctly different paths, producing a wide dispersion of returns that reinforced the importance of regional and asset-class diversification. Small-cap leadership north of the border, contrasted with large-cap dominance in the U.S., became one of the defining themes of the year.

Canada: Small Caps Take the Lead

Canadian equities delivered an exceptional year, with strength broadening meaningfully beyond the largest names. The S&P/TSX Composite Index gained 31.68% for the year, reflecting solid performance across financials, energy, and materials as commodity prices stabilized and domestic economic conditions improved.

Small-cap equities were the standout. The TSX Small Cap Index surged 46.97%, decisively outperforming large caps. This rally reflected renewed confidence in domestically focused businesses, improving access to capital, and a growing appetite for value and cyclical exposure as interest rate pressure eased. Investors who remained patient through prior periods of underperformance were rewarded as smaller companies benefited from both multiple expansion and improving fundamentals.

Monetary policy provided a supportive backdrop. The Bank of Canada delivered a 25-basis-point rate cut in the fourth quarter, bringing the overnight rate to 2.25%. With upward momentum on inflation fading and economic growth showing signs of moderation rather than contraction, the central bank’s shift reinforced confidence that policy was no longer a headwind. Rate-sensitive sectors responded positively, further supporting equity market momentum into year-end.

United States: Large Caps Hold the Advantage

U.S. markets posted solid but more uneven results. The S&P 500 advanced 17.88% over the year, driven primarily by large-cap technology and AI-linked companies that continued to dominate earnings growth and investor attention. While market leadership remained concentrated, strong balance sheets and resilient profit margins helped justify elevated valuations.

In contrast, small-cap performance lagged meaningfully. The S&P 600 Small Cap Index gained just 4.47%, reflecting tighter financial conditions for smaller firms, higher refinancing sensitivity, and a slower transmission of monetary easing. Despite improved sentiment later in the year, investors remained selective, favouring scale, pricing power, and earnings visibility.

The Federal Reserve began easing policy in the fourth quarter, cutting the federal funds rate twice by 25 basis points to end the year at 3.75%. While these moves signalled confidence that inflation was under control, the pace and timing of cuts underscored the Fed’s cautious approach. Markets responded positively, though the impact was felt more clearly in large-cap equities than in smaller, more rate-sensitive segments.

Looking Ahead

As 2025 came to a close, the investment landscape was far healthier than it appeared at the start of the year. Inflation moderated, central banks shifted from restraint to support, and market leadership began to broaden—particularly in Canada. At the same time, dispersion remains elevated, reinforcing that returns are being earned through positioning rather than simply market exposure.

The year’s results highlight a simple but enduring truth: long-term outcomes are shaped less by headlines and more by discipline, diversification, and a willingness to stay invested when conditions are uncomfortable.

In a year marked by sharp contrasts and shifting narratives, steady strategy—not speculation—made the difference.

Written By: Alexander McCallum