The US economy ended 2025 on a weaker-than-expected note.
New data from the Bureau of Economic Analysis showed GDP grew at an annualized rate of just 1.4% in the fourth quarter, well below economist expectations for 2.9% growth. The miss marks a notable slowdown from earlier in the year and caps full-year 2025 growth at 2.2%, down from 2.8% in 2024.
A key culprit: government spending.
Federal outlays fell sharply during the quarter, reflecting the impact of the 43-day government shutdown that spanned October and November. Overall government spending declined at a 5.1% annualized rate, subtracting 0.9 percentage points from headline GDP. Federal spending alone plunged 16.6%, shaving 1.15 percentage points off growth.
President Trump, posting on Truth Social ahead of the release, argued the shutdown cost the economy “at least two points in GDP” and renewed calls for lower interest rates.
Under the Surface: Not All Weakness
Despite the headline disappointment, underlying private-sector demand remained more resilient.
Real final sales to private domestic purchasers — a key gauge of core demand — rose 2.4%, only slightly below the prior quarter’s 2.9% pace. Private fixed investment increased 2.6%, supported by continued spending on intellectual property and information processing equipment.
The AI build-out remains a meaningful contributor to growth. Spending on information processing equipment added 0.65 percentage points to GDP in the quarter, while investment in intellectual property products rose at a 7.4% pace.
However, consumer behavior showed signs of divergence. Services spending grew 3.4%, while goods spending fell 0.1%, underscoring a continued rotation away from physical goods.
What This Means for Small-Cap Stocks
For small- and micro-cap investors, the implications are layered.
First, government spending volatility tends to disproportionately impact smaller companies with federal exposure. Contractors, niche defense suppliers, and specialized service providers may have felt the brunt of delayed payments or paused contracts during the shutdown.
Second, slower headline GDP growth can pressure investor sentiment toward riskier asset classes — and small caps often sit at the front of that risk spectrum. The Russell 2000 historically reacts more sharply to growth scares than large-cap indices.
But there’s another side.
If economists are correct that shutdown-related drag reverses in the first quarter — with some forecasts calling for 3% growth in early 2026 — small caps could benefit from a rebound narrative. Lower rates, which the administration continues to push for, would also ease capital constraints for smaller companies that rely more heavily on credit markets.
And the ongoing AI investment cycle may continue to support smaller industrial, semiconductor-adjacent, and specialty tech names tied to infrastructure build-outs.
Bottom Line
The Q4 GDP miss highlights how policy disruptions can ripple through the broader economy. While headline growth slowed, core private demand and investment remain intact.
For small-cap investors, volatility may persist in the near term — but a rebound in government activity and continued capital investment could shift the narrative quickly in early 2026.