Franklin Templeton: Broad participation. Bullish Rotation
Market Update – December 5, 2025
Broad Participation and Signs of a Bullish Rotation
As we move into the final month of the year, recent economic and market data continue to paint a picture of surprising resilience in the U.S. economy. Below is an overview of key developments across macroeconomic conditions, equities, fixed income, and investor sentiment.
U.S. Macro Environment
Recent estimates from the Atlanta Federal Reserve suggest that third-quarter economic activity remained healthy, with real GDP tracking close to 4% annualized growth.
Meanwhile, the labor market—though still strong—has shown slight softening. The unemployment rate recently ticked up to 4.3%, the highest level in several years. With the Federal Reserve preparing for its December meeting, this uptick could shift some of the focus back toward employment within the Fed’s dual mandate.
Interest-rate expectations remain uncertain. A number of Fed officials have signaled openness to another rate cut, and futures markets have been adjusting quickly to every comment, driving short-term volatility. Market pricing has increasingly leaned toward the likelihood of a modest 0.25% cut.
Inflation expectations have continued to cool across multiple timeframes. One-, two-, and five-year breakeven rates have moved near their lowest levels of the year, suggesting improved confidence that inflation is trending closer to the Fed’s long-term goal.
If the unemployment rate continues higher while inflation expectations fall, the Fed may see additional justification to ease policy again.
Equity Markets: Broadening Strength
Recent swings in equity prices should not be surprising, given that markets historically behave this way when the Fed resumes cutting rates. Past cycles have often produced higher-than-normal volatility early on, followed by strong performance over the following year.
A notable development in recent weeks has been the improvement in market breadth. Several areas outside the largest growth stocks—such as value-oriented large caps, mid-caps, and small caps—have reached new record highs. By contrast, megacap technology and growth names have not yet matched those new peaks.
This type of rotation is generally considered healthy, as it signals that investors are finding opportunities across a wider set of companies. Much of this momentum is being supported by forward-looking earnings projections, which remain solid across nearly every major segment of the market. Historically, stock prices have tended to follow earnings growth, and recent data support that relationship.
Earnings have played an especially important role in shaping market performance over the last year. Research shows that the majority of the S&P 500’s gains during the past 12 months can be attributed directly to companies’ profit growth, with smaller contributions from dividends and changes in valuation multiples. With expectations for continued earnings expansion into 2026 and 2027—both in the U.S. and internationally—there is still a compelling case for maintaining exposure to global equities.
Financial institutions have also shown notable strength. Several major U.S. banks recently touched new highs, which historically has been an encouraging sign for broader market stability.
Fixed Income: Shifting Yields and Opportunities
Bond markets have been particularly volatile from day to day, especially following the Fed’s October meeting. Ten-year Treasury yields have moved within a tight range near 4%, while shorter-term yields have declined more noticeably, contributing to a slight steepening of the yield curve.
Looking ahead to 2026, a continued steepening trend is a reasonable expectation. Many analysts anticipate that shorter-duration bonds and corporate credit may outperform cash again next year, especially as investors look for income opportunities in a potentially lower-rate environment.
Concerns about corporate credit weakness have not yet shown up in the data. Investment-grade and high-yield spreads both remain near long-term averages, suggesting that underlying fundamentals remain stable.
Municipal bonds and higher-quality corporate bonds continue to look attractive within diversified portfolios.
Investor Sentiment
Investor outlook shifted meaningfully over the past several weeks. Surveys show a rise in the percentage of individuals expecting gains over the next six months, while bearish expectations have dropped sharply. Although these readings are not yet extreme, they merit close attention, as sentiment indicators can serve as useful contrarian signals.
As the holiday season approaches, market conditions remain dynamic but generally constructive, supported by steady economic growth, broadening equity participation, and moderate inflation expectations. We look forward to seeing how policy decisions and corporate performance shape the landscape heading into 2026.
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