On January 20, 2025, Donald Trump took the oath of office for a second time, inheriting an economy that many predicted would buckle under his policy agenda. Critics warned that sweeping tariffs would trigger recession, that battles with the Federal Reserve would destabilize markets, and that geopolitical confrontation would send investors fleeing to safety.

One year later, the numbers tell a different story. The S&P 500 generated a total return of 17.9% in 2025, the Dow Jones Industrial Average added 14.9%, and the Nasdaq Composite surged 21.4%. As the president prepares to mark his anniversary on Monday—with markets closed for Martin Luther King Jr. Day—the question has shifted from whether Trump would crash the market to whether the rally can continue.

The Year in Review: A Rollercoaster with an Upward Trend

The path to 17.9% was anything but smooth. The S&P 500 experienced a nearly 20% drawdown in April 2025 when the administration announced comprehensive tariffs that exceeded market expectations. For seven weeks, investors feared a global trade war would derail the expansion.

But the market's resilience proved remarkable. From that April low, the S&P 500 surged nearly 40%, reclaiming record highs and then pushing higher still. The Dow Jones Industrial Average crossed 49,000 for the first time, a milestone that seemed unthinkable during the spring turmoil.

What Drove the Rally?

Several factors combined to power markets higher despite the policy turbulence:

AI Investment Boom

The artificial intelligence spending wave intensified throughout 2025, with the Magnificent Seven tech giants committing over $600 billion to AI infrastructure. Nvidia's stock soared as data center demand exceeded even bullish projections. The AI trade showed no signs of exhausting itself, despite periodic rotation into other sectors.

Resilient Consumer Spending

American consumers defied recession predictions, continuing to spend even as prices remained elevated. Unemployment stayed below 4.5% for most of the year, supporting wage growth and consumer confidence. The feared collapse in spending never materialized.

Federal Reserve Accommodation

The Fed cut rates three times in 2025, bringing the federal funds rate to the current range of 3.5% to 3.75%. While inflation remained sticky above the 2% target, the central bank prioritized supporting the labor market and economic growth.

Tariff Flexibility

Despite aggressive rhetoric, the administration showed willingness to negotiate and delay tariff implementations. Markets learned to distinguish between threats and actions, pricing in less disruption than initially feared.

The January 2026 Outlook

As Trump's second year begins, the market enters 2026 with mixed signals. Through mid-January, the S&P 500 has added just 1.5%, while the Russell 2000 small-cap index has surged more than 8%—a potential sign of rotation away from mega-cap tech dominance.

Wall Street strategists remain broadly bullish, with most year-end targets clustering between 7,500 and 8,000 for the S&P 500. But historical patterns suggest caution: midterm election years historically see larger corrections, with average peak-to-trough declines of 17.5% since 1950.

Key Risks for Year Two

Investors watching Trump's second year should monitor several potential catalysts for volatility:

  • Fed Chair Transition: Powell's term expires in May, and the selection of his replacement could significantly impact monetary policy expectations
  • Tariff Escalation: New semiconductor tariffs took effect January 15, and additional measures could follow, particularly targeting China
  • Inflation Resurgence: Core CPI remains at 2.6%, and tariff-driven price increases could push inflation higher
  • Geopolitical Flashpoints: Taiwan tensions, Middle East instability, and European security concerns all pose risks to global markets
  • Valuation Concerns: At a forward P/E of 22.2, the S&P 500 trades well above its 10-year average of 18.8

What the Bond Market Is Saying

While equity markets have celebrated, the bond market has been more cautious. Treasury yields retreated from recent highs but remain elevated, reflecting persistent inflation concerns and uncertainty about fiscal policy. The 10-year yield hovers near 4%, suggesting fixed-income investors see continued inflation risk.

The dollar has shown a "V-shaped" pattern that currency strategists expect to continue—weakness in the first half of 2026 followed by potential strength later in the year as Fed policy and trade dynamics evolve.

Historical Context: Second-Year Performance

For historical perspective, second-year presidential terms have produced varied results:

  • Reagan's second year (1986): S&P 500 +14.6%
  • Clinton's second year (1998): S&P 500 +26.7%
  • Bush's second year (2006): S&P 500 +13.6%
  • Obama's second year (2010): S&P 500 +12.8%
  • Trump's first second year (2018): S&P 500 -6.2%

The wide range of outcomes underscores that presidential policy is just one of many factors driving market returns.

Positioning for What's Ahead

For investors considering how to position for Trump's second year, several themes emerge:

  • Diversification matters more: With mega-cap concentration at extreme levels, broader market exposure may reduce risk
  • Small caps show promise: The Russell 2000's strong January suggests rotation may be underway
  • Watch the Fed transition: The new chair's policy stance will significantly impact interest-rate-sensitive sectors
  • Don't fight the tape: Despite elevated valuations, momentum remains positive and earnings continue to grow

Trump's first year delivered returns that few predicted. Whether year two can sustain the momentum will depend on the interplay of policy, profits, and the always-unpredictable evolution of market sentiment. For now, the bulls remain in control—but the skeptics are still watching.