Q3 2025 Commentary

As we move into the final quarter of 2025, markets are navigating a complex mix of slowing growth, stubborn inflation, shifting policy, and renewed political uncertainty. The third quarter reinforced that the U.S. economy remains resilient but uneven, with momentum varying sharply across sectors. The government shutdown that began at the start of the new quarter has only added another layer of uncertainty, complicating the near-term outlook.

After a surprisingly strong first half, the economy likely expanded at roughly 2.5% annualized in the third quarter, supported by steady consumer spending and business investment. Yet several crosscurrents are taking hold. Tariffs, reduced federal spending, and a sharp slowdown in immigration are weighing on activity and are expected to pull growth below 0.5% by year-end before it rebounds early next year. The recently passed OBBBA legislation, which includes large income-tax refunds, should provide a short-term boost to household spending in the first half of 2026, followed by renewed moderation as that stimulus fades and higher tariffs and lower immigration again restrain growth.

The labor market has cooled in line with the broader economy. Payroll gains have slowed sharply— from about 150,000 per month earlier this year to fewer than 50,000— the weakest pace since the pre-pandemic slowdown. Even so, the sharp drop in immigration is limiting the rise in unemployment. With both legal and illegal immigration significantly lower, the pool of available workers is barely growing, which should keep the unemployment rate near 4.5% while holding wage growth steady.

Nonetheless, inflation remains sticky. Tariffs are now feeding through to prices, with headline CPI approaching 3% year-over-year and likely rising toward 3.7% by year-end. The anticipated tax refunds could temporarily lift prices through mid-2026, but as growth cools again, inflation should gradually ease toward the Fed’s 2% target by 2027.  As we know from recent inflation experience, there are a lot of variables that could disrupt that trajectory in the meantime.

The Federal Reserve resumed cutting rates in September, lowering the federal funds rate by a quarter point, and is expected to continue easing through early 2026. Even so, policy remains somewhat restrictive. The Fed faces the difficult task of balancing elevated inflation against softening growth, all while maintaining its independence amid political pressure from Washington.

At the same time, the shutdown has disrupted the flow of key economic data, leaving investors and policymakers with fewer signals to gauge real-time conditions. Historically, shutdowns have been brief with modest effects, but a prolonged impasse could dampen confidence as we enter the holiday spending season.

An additional challenge is the limited flexibility policymakers now face because of the government’s heavy debt burden and large fiscal deficits. In past downturns, the Fed and Congress often worked in tandem—combining lower rates with fiscal stimulus—to stabilize growth. Today, with federal debt exceeding 120% of GDP and interest payments consuming a growing share of the budget, that playbook is harder to repeat. While targeted programs like the OBBBA may offer temporary relief, broad fiscal support would likely meet political resistance and could complicate the Fed’s inflation fight. As a result, future policy responses may be more constrained, heightening the importance of private-sector adaptability and prudent portfolio management.

In equity markets, U.S. mega-cap stocks continue to dominate performance, with the ten largest companies now accounting for nearly 40% of the S&P 500’s market value. While earnings strength—especially in technology and AI—helps justify their leadership, valuations are stretched, approaching levels last seen during the late-1990s dot-com era. We are gradually diversifying away from these concentrated exposures and increasing allocations to areas with more attractive valuations, including international equities, particularly in Europe.

In fixed income, a softening economy and Fed easing have supported bond prices, while heavy Treasury issuance and lingering inflation concerns have provided offsetting pressure. We remain neutral on duration – that is, our exposure to changes in interest rates – since yields now appear fairly valued. However, we are tilting away from corporate credit, where investors are taking on more company-specific risk for relatively little additional return. Credit spreads – the difference in yield between corporate bonds and safer U.S. Treasuries – remain unusually tight, suggesting investors are being paid less than usual to take that extra risk. We are also monitoring the private-credit market, where higher borrowing costs and limited transparency could reveal stress if growth slows further.

Looking ahead, we expect next year to bring a “stop-and-go” pattern of growth—a short-term pickup followed by renewed moderation. The crosscurrents of tariffs, fiscal stimulus, and immigration will shape the economy’s rhythm, while the Fed and markets continue to oscillate between vigilance and patience. Whether this journey feels more like the annoyance of stop-and-go traffic or the turbulence of a flight path will depend largely on how policymakers steer through a world of limited flexibility and rising fiscal strain.

Given these shifting conditions, our focus remains on preserving flexibility, identifying value where it emerges, and ensuring portfolios stay aligned with each client’s long-term goals.