10.06.2025
The Quarter in Brief
The third quarter delivered broad-based gains: U.S. stocks rallied roughly 5-11%, bonds posted positive returns, and gold extended its upward trend. The S&P 500 gained approximately 8%, the Nasdaq around 11%, and the Dow roughly 5%—each hitting fresh all-time highs in September. Beneath the surface, the labor market weakened, inflation remained sticky, and valuations climbed to levels not seen since the late 1990s. Market volatility stayed unusually low.
Equities: Technology Leads, Again
U.S. equity markets extended their rally, with year-to-date returns reaching 13.7% for the S&P 500, 17.3% for the Nasdaq, and 9.1% for the Dow as of September 30. The drivers: AI optimism, the Fed's September rate cut, and strong mega-cap tech earnings. Returns remained concentrated in large-cap growth. Developed international equities (MSCI EAFE) returned approximately 4.8% in Q3; emerging markets gained in the high single to low double digits.
The AI question: Amazon founder Jeff Bezos recently addressed whether we're in an AI bubble. "When people get very excited... every experiment gets funded, every company gets funded—the good ideas and the bad ideas," he said at Italian Tech Week. But he stressed: "It doesn't mean that anything that is happening isn't real."
AI is driving productivity gains across industries. The technology works. The question is how quickly benefits materialize, which companies capture the value, and how much is already priced in. The internet boom of the late 1990s was both a speculative frenzy and a genuine revolution—being right about the technology didn't protect investors from painful losses if they owned the wrong companies or bought at the wrong time.
A portfolio heavily weighted toward mega-cap technology stocks will behave very differently than a diversified portfolio. Neither approach is right or wrong, but it's worth understanding which one you have.
Other Market Movers
A few other cross-currents are worth noting.
Gold's continued strength: Gold rallied throughout Q3 and set a fresh all-time high in early October. While traditional "safe haven" narratives often dominate headlines, the rally appears driven at least in part by global bond market dynamics and diversification flows from international investors.
Private credit stress: Select segments of the private credit market are showing strain—an outcome of years of rapid growth and loose underwriting during the low-rate era. This doesn't signal broad systemic risk, but it reinforces the importance of quality over reaching for yield.
Low volatility: The VIX closed at 16.28 on September 30, well below its long-term average. Low volatility often means markets aren't pricing in much risk—conditions that can change quickly.
Fixed Income: A Rare Win for Bonds
Bonds had a strong quarter—the Bloomberg U.S. Aggregate Bond Index up 2.0% in Q3 and 6.1% year-to-date. The 10-year Treasury yield ended near 4.16%, down from mid-year highs. The rally was driven by the Fed's 0.25% rate cut in September (bringing the target range to 4.00-4.25%), weaker labor data, and investor demand for safety as equity valuations stretched.
Inflation and the Labor Market: Mixed Signals
Headline CPI rose to 2.9% year-over-year in August; core CPI held at 3.1%—both above the Fed's 2% target. U.S. employers added just 22,000 jobs in August, unemployment ticked up to 4.3%, and the BLS revised prior employment data down by 911,000 jobs between April 2024 and March 2025. The labor market has been weaker than real-time data indicated. The Fed's September rate cut marked a shift from "higher for longer" to "normalizing before the labor market deteriorates further." Markets took this positively—rates are coming down, but not because of crisis.
Valuations: Extended, But Not Unprecedented
With the Fed cutting rates into a softening economy, investors have focused on whether current equity valuations leave room for disappointment.
U.S. stocks are expensive by historical measures. The Shiller P/E ratio reached approximately 38.6 at quarter-end—roughly 74% above its long-term CAPE trendline and the highest level since 2021. The long-term average sits around 17.6.
Valuations can stay elevated for years, or they can revert quickly. Markets have surprised forecasters in both directions more times than anyone cares to count. When valuations are stretched, there's less room for error. If earnings disappoint or growth slows, the market has less cushion to absorb bad news. If growth accelerates or earnings surprise to the upside, high valuations can go higher.
The practical takeaway isn't about predicting outcomes—it's about understanding what you own and whether your portfolio can handle a range of scenarios.
What We're Watching in Q4
Labor market momentum: Continued weak payroll prints would likely prompt more aggressive Fed cuts—supporting bonds but signaling real economic weakness. The next few months of employment data will clarify whether August was an anomaly or the start of a trend.
Earnings season: Tech stocks are priced for perfection. Disappointing results or guidance could trigger rotation out of mega-cap growth, creating short-term volatility. Conversely, strong results could extend the rally even as valuations stretch further.
Volatility: Low VIX readings suggest complacency. History shows that when markets aren't pricing in much risk, conditions can shift quickly—in either direction.
The Takeaway
Q3 was strong, but the fundamentals are complex: valuations are stretched, the labor market is weakening, and inflation hasn't normalized. This isn't a moment for panic or complacency—just clear-eyed assessment of where we are in the cycle.
If you'd like to review your portfolio in light of Q3 developments or anything else, let's schedule a time to talk.