Q3 2025 Market Review

By Brian Baum, CEPA®, CFP®

Markets delivered strong returns in Q3 despite tariff tensions, political dysfunction, and weakening labor market data that raised concerns about economic momentum. The S&P 500 gained 8.1% while the Nasdaq surged 11.4%, extending a multi-year rally increasingly concentrated in technology. International stocks trailed but continue to outpace U.S. markets year-to-date (26.64% vs. 14.8%), and bonds rallied as the Fed cut rates for the first time in 2025.

Economic Snapshot

• Growth remains relatively strong, fueled by substantial AI infrastructure spending and resilient consumer spending among higher earners

• Job creation has slowed, with recent reports missing expectations

• Tariffs are adding modest inflation pressure, but disinflation in housing, cooling wage growth, and easing labor markets seem to be prevailing

• Fed pivots to support jobs: September's 25bp rate cut signaled prioritization of employment over inflation concerns, with additional cuts signaled by year-end

Market Performance

US Equities: AI Dominating

The rally was fueled by sharp recoveries in recent laggards like Apple (+24.25%), Alphabet (+38.07%), and Tesla (+40%), alongside the usual AI suspects—Nvidia (+18.1%) and Broadcom (+19.89%)—as investors rotated back into the Magnificent 7 cohort on renewed confidence in AI monetization and consumer tech resilience.

What's working:

• AI infrastructure spending from large, cash-rich technology companies

• Actual revenue today: Major cloud platforms posting strong AI-driven growth; enterprises making substantial AI investments

• Supply can't keep up: Data centers operating at high capacity with limited availability

What's concerning:

• Extreme concentration: Multiple years of returns packed into a small number of stocks

• Elevated valuations: S&P 500 trading at 22.8x vs. 30-year average of 17x ¹

• Dependence on one theme: Market rally heavily dependent on AI infrastructure spending—if returns on this capital disappoint, the impact could be severe

International Equities: Lagging Quarterly but Leading YTD

International equities slightly underperformed U.S. markets in the third quarter, with developed and emerging market stocks (MSCI ACWI ex US) gaining 7.03%.  Supported by favorable policies in Europe and China, attractive valuations, and a weakening U.S. dollar, foreign stocks still lead their US counterparts on a YTD basis.

Fixed Income: Rally on Falling Rates

Falling short- and intermediate-term rates, alongside a steeper yield curve, propelled bonds higher in Q3:

• Bloomberg Barclays US Aggregate: +2.03% Q3 | +6.13% YTD

• Positioning: Selectively extending duration for price appreciation and income

• Municipals: Attractive tax-adjusted yields

• When Looking For Yield: Diversify across high-quality securitized assets and emerging markets debt

  
  

How We’re Positioning

1. Technology: Stay selective, manage concentration

• We don’t think this is a redo of 1999. Unlike the dot-com bubble (borrowed money, no revenue, unused infrastructure), today's AI spending is funded by companies generating substantial free cash flow, monetizing AI services currently, with infrastructure operating at high capacity.

• But concentration is extreme. Tax-loss harvesting can be used to rebalance without triggering unnecessary gains, maintaining exposure to proven leaders with an eye towards diversification rather than concentrated bets.

2. International: Maintain Strategic Exposure

• International stocks trade at discounts to U.S. markets, benefit from supportive policy in major economies, and provide currency diversification.

• Active management may be appropriate for regional/stock specific opportunities.

• Maintain meaningful exposure while managing overall allocation.

3. Alternatives: Diversify Beyond Traditional Markets

• Gold and Bitcoin both posted gains in Q3, serving as hedges against currency, policy, and geopolitical risks.

• Private equity/credit and infrastructure (airports, utilities, data centers) potentially offer stable cash flows, inflation protection, and access to AI infrastructure through real assets versus equity volatility.

• For qualified investors with long time horizons, disciplined exposure to AI-focused venture capital can capture opportunities unavailable in public equities while complementing mature private equity allocations.

The Bottom Line

Markets have delivered exceptional returns, but to us they look expensive, concentrated, and dependent on a single narrative: AI infrastructure. The fundamentals supporting AI investment are solid—real revenue, real demand, real capacity constraints—but the market has priced in substantial optimism with little room for error.

Our approach: Maintain exposure to structural winners while rebalancing to avoid concentration risk, extend duration to capture bond opportunities in a falling-rate environment, diversify internationally where valuations and policy are supportive, and add alternatives for resilience and growth when traditional markets falter.

*The return statistics and figures provided in this material were gathered from YCharts as of 09/30/2025. These figures are for informational and educational purposes only and not to be construed as investment advice.

*AI tools were used to assist in the formatting of this commentary. The information included in the commentary is original content and was not created by AI tools.

¹Source: Bloomberg, FactSet, Moody’s, Refinitiv Datastream, Robert Shiller, Standard & Poor’s, J.P. Morgan Asset Management. Forward P/E ratio is the most recent S&P 500 index price divided by consensus analyst estimates for earnings in the next 12 months, provided by IBES since March 1994 and FactSet since January 2022. Shiller’s P/E uses trailing 10-years of inflation-adjusted earnings as reported by companies. Dividend yield is calculated as consensus estimates of dividends in the next 12 months, provided by FactSet, divided by the most recent S&P 500 index price. EY minus Baa yield is the forward earnings yield (the inverse of the forward P/E ratio) minus the Bloomberg U.S. corporate Baa yield since December 2008 and interpolated using the Moody’s Baa seasoned corporate bond yield for values beforehand. Guide to the Markets – U.S. Data are as of September 30, 2025.

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