Q3 2025: Thoughts on the Investment Markets

“The only function of economic forecasting is to make astrology look respectable.” Quote attributed to John Kenneth Galbraith.

• Equity markets surged in the third quarter, led once again by large-cap technology stocks.
• Bond markets rallied in the third quarter as the Federal Reserve (Fed) cut interest rates in September and signaled more accommodative monetary policy going forward.
• While economic growth remains strong, inflation continues to be stubbornly above the Fed’s 2% target rate and the labor market has begun to show more signs of weakening.

Economic Review and Outlook

Financial markets navigated a complex environment in the third quarter, characterized by resilient economic growth, a slowing labor market, and inflation remaining stubbornly above the Fed's 2% long-term target. GDP grew 3.8% in the second quarter, well above its long-term trend of 2%, with similar estimates penciled in for the third quarter. While some of the economic growth in the second quarter may be attributable to a decrease in imports as consumers and businesses front-loaded imports in the first quarter ahead of tariff implementation, growth has also been fueled by strong consumer spending, particularly amongst the highest earners. Booming investment in the build-out of artificial intelligence (AI) infrastructure has been another important factor contributing to the impressive resilience of the U.S. economy.

Despite robust economic growth in the second quarter, labor markets have begun to weaken. The most recent jobs report showed the U.S. economy added only 22,000 jobs in August, well below consensus expectations of 75,000 new jobs. In the same report, jobs growth was revised down for June (from 14,000 jobs gained to 13,000 jobs lost), while it was revised upwards by 6,000, to 79,000 jobs, in July. These revised numbers brought the total number of jobs created to 598,000 year-to-date through August. Except for the pandemic-marred year of 2020, this is the fewest number of jobs created in the first eight months of a calendar year since 2009, when the country was still in the midst of the global financial crisis. While health care and social assistance have been the best-performing segments for job creation in recent months, there is some fear that decreased federal funding will begin to negatively impact employment in these segments, clouding the hope for a near-term recovery in the job market.

In response to the weakening labor market, the Federal Open Market Committee voted to cut rates by 25 basis points in September, lowering the benchmark overnight lending rate to a range of 4.00%-4.25%. This marked the first reduction in rates in 2025, with policymakers signaling two more cuts are likely before year-end. Fed Chair Jerome Powell characterized the Fed’s easing in September as "risk management" to address recent weakness in the labor market, while acknowledging that inflation remains somewhat elevated. He also indicated that the Fed would remain focused on their twin mandate of stable prices and full employment, reiterating that future Fed policy would remain data dependent. Until there is greater clarity around the path of future monetary and fiscal policy, it seems that levels of uncertainty in financial markets will remain elevated.

Stock Market Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

Equity markets continued their ascent in the third quarter, driven by a resilient economy, stronger-than-expected earnings growth, and expectations of more accommodative monetary policy from the Fed. The primary drivers in this rally have been large-cap growth stocks, particularly those companies that are benefiting from the boom in AI, such as the “Magnificent 7” stocks. International stocks continued to perform well in the third quarter as well, with both developed and emerging markets outperforming the S&P 500 Index by more than 11% year-to-date.

Earnings have played a major role in supporting equity market performance. Estimated year-over-year earnings growth for the S&P 500 was 7.9% in the third quarter, the ninth consecutive quarter of relative earnings growth for this index. In the third quarter, Information Technology stocks grew earnings by 20.9% year-over-year, while the Consumer Discretionary (-2.7%), Consumer Staples (-3.2%) and Energy (-3.4%) sectors posted negative year-over-year earnings growth over the same period. On an actual basis, there was significant dispersion across sector performance in the quarter as well. Communication Services and Information Technology stocks led the way by surging forward 13.2% and 12.0%, respectively, while Consumer Staples stocks were the laggards, falling -2.4%.

Exposure to international equities continued to be beneficial to U.S. investors in the third quarter. Supportive policies in both Europe and China have buttressed their equity markets, while a weakening U.S. dollar has provided U.S.-based investors with an additional performance tailwind. Expectations for continued policy support in developed countries, a U.S. dollar that remains relatively strong by historical standards, and attractive relative valuations are all contributing to an environment that seems relatively favorable for international stocks.

Bond Market Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

Bond markets rallied in the third quarter as interest rates fell, first in anticipation of and then in reaction to, the Fed lowering the Fed Funds rate in September. While short-term and intermediate-term rates declined in response to the Fed’s actions, longer-term rates remained higher, resulting in a steeper yield curve. The downward shift in the curve led to positive bond performance in aggregate as investors received the double benefit of higher starting yields and falling interest rates. While shorter-term bonds rallied in price as yields have fallen, they will earn lower yields going forward, all else remaining equal. Longer-term bonds now offer more attractive yields relative to short-term bonds, given the steepness of the yield curve.

U.S. Treasury Yield Curve

Source: Bloomberg. This market information is being provided for informational purposes and does not represent returns achieved by Corient or the experiences of any particular client. Data as of 9/30/2025.

Municipal bonds rallied more than the broad bond index over the period as investor demand increased in light of attractive tax equivalent yields. Some of this rally may be due to investors reacting to the risk of falling short-term interest rates, as they moved capital out of cash and into higher-yielding and longer-duration assets that should benefit in an environment of flat or falling interest rates.

Portfolio Implications

Elevated levels of economic uncertainty driven by a lack of policy clarity seems likely to continue going forward. Stock markets are now one quarter away from three straight calendar years of exceptional performance, which has been concentrated mainly among large-cap U.S. growth stocks. Given this narrow leadership in performance, being able to realize profits in a tax-efficient manner and reallocate across a strategically diversified portfolio remains a good prescription for many long-term investors.

• The ongoing exceptional performance of the Magnificent 7 stocks has been a boon for U.S. equity market investors. This type of extended outperformance by a small group of stocks presents investors with a challenge that is made more difficult by the potential tax liabilities created by the strong performance. Disciplined tax-loss selling strategies can help investors offset some of the gains earned in outperforming sectors, and allow for a strategic rebalancing of portfolios to long-term target weights. This measured rebalancing enables investors to potentially benefit from opportunities that may arise in other areas of the market. It also allows investors to diversify their equity market risks without giving up all their exposure to growth stocks that continue to be global leaders in the fast-growing Information Technology sector. By following a strategic approach, investors may be able to maintain their long-term plan without subjecting themselves to the uncertainty of trying to time entry and exit points, which can be especially difficult during bull markets.
• The strategic case for owning international stocks has always centered around the themes of broadening the investment opportunity set and geographic diversification. Thus far in 2025, international stocks have been key drivers of portfolio performance. Many of the factors that have contributed to this strong performance in international markets remain in place. Although U.S. equity market valuations are at high levels relative to historical averages, many global markets are much more reasonably valued, and a weakening U.S. dollar continues to provide a tailwind for U.S.-based investors. While continued weakness in the dollar is far from guaranteed, falling interest rates in the U.S., expanding fiscal deficits and decreasing levels of global trade could combine to lower demand for dollar-based assets. There is no guarantee that this relative outperformance will continue, but the current environment remains relatively favorable, and the strategic rationale of a wider set of investment opportunities and geographic diversification remains intact.
• With modestly lower interest rates, which could continue to fall should the Fed follow through with more rate cuts, investors now face a bond market featuring lower short-term rates and increasingly higher rates as maturities get longer. The steeper yield curve is supportive of extending duration in bond portfolios as longer-dated bonds continue to provide investors with attractive starting yields and the possibility of price appreciation should interest rates fall. The higher starting yields of these longer-term bonds provide an increased income cushion in the event interest rates rise and bond prices fall as a result. For investors who use fixed income to diversify equity market risk and enhance stability to their portfolio, adding duration to their bond portfolio can help mitigate some of the risk inherent in the short and long parts of the yield curve, since the longer-duration bonds will generally perform well should rates continue to fall. Similarly, by owning intermediate-duration and longer-duration municipal bonds, taxable investors may benefit from the current environment of a steep yield curve, the potential for falling interest rates due to a Fed easing cycle, and attractive tax-adjusted yields.
• More contrarian investors may be getting a little nervous after two years of strong market performance, so an allocation to alternative investments can be an option for diversifying market risk going forward. Alternative investments are a way for investors to broaden their opportunity set in an uncertain environment. These investments may offer exposure to a different set of economic drivers of returns than public securities. For example, infrastructure investments can provide investors with access to stable, predictable cash flows from investments in assets such as airports or utilities, as people will continue to travel and use electricity throughout the economic cycle. These investments can also have a quasi-monopolistic nature that gives them durable competitive advantages and inflation protection characteristics as a result of contractual or regulatory inflation-escalation mechanisms. Alternative asset classes like private real estate, private credit and hedge funds, among others, may provide further diversification to return drivers that are difficult to access in public markets.

Conclusion

As we enter the homestretch of 2025, there seems to be no sign that the policy uncertainty and geopolitical risks that have been primary drivers of volatility this year will be abating any time soon. As well, continued growth in the Magnificent 7 stocks seems as inevitable as the sun rising in the morning. In environments like this, investors may feel tempted to choose a side. It might be comfortable to simply capitulate and overweight the investments that have been the best performers. After all, it’s very easy to back recent winners and assume that the past will continue to repeat itself. For those of a more contrarian bent, it might be tempting to move in the opposite direction and bet on a reversal of recent trends. However, while both approaches may seem tempting, they are also fraught with risk. A reliance on forecasting the future direction of markets or the economy is a trap that has ensnared many investors over the years. A strategic approach that balances both risks and opportunities can help investors navigate the future, regardless of their ability to foretell the future. A disciplined approach may not be as exciting or as comforting in the moment, but it seems to be a much wiser strategy than simply relying on a guess as to what the future may hold.

If you have questions about your plan or how your investment portfolio is positioned amid current macroeconomic and geopolitical challenges, feel free to contact your Corient Wealth Advisor.

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