Quarterly Update

Market resilience was a theme during the third quarter (Q3) of 2025, buoyed by investor enthusiasm about AI-related spending, an overall healthy economy and, perhaps ironically, an interest rate cut by the Federal Reserve. Investors contended with any number of crazy headlines and a federal government shutdown as the quarter ended but still managed to keep major stock indexes in “overbought” territory for most of Q3.

Here's a summary of how major market indexes performed during the quarter and year-to-date, respectively.

• US Large Cap Stocks: up 8.1% and up 14.7%
• US Small Cap Stocks: up 12.5% and up 10.4%
• US Core Bonds: up 2% and up 6.1%
• Developed Foreign Markets: up 4.5% and 25.6%
• Emerging Markets: up 10.7% and 28.9%

US stocks performed well during Q3, as did stocks overseas. Generally speaking, investors continued moving past concerns about tariffs and inflation while shifting focus toward declining interest rates, government spending plans here and abroad, and corporate spending on AI-related infrastructure. According to Bespoke Investment Group, the big five AI-related companies (Meta, Google, Microsoft, Oracle, Amazon) spent roughly $40 billion on US data centers in July alone, with plans to spend around $1 trillion over the next year. Others suggest this spending could grow to several trillion by the end of the decade. More data centers are necessary to power the proliferation of AI models and their ability to “reason” which, according to NVIDA, could need over 100 times the power of earlier AI models.

All this growth impacts market dynamics. There are now nine publicly traded companies with $1+ trillion market valuations and eight of those are tech-related and the Technology sector makes up nearly 36% of the S&P 500. Add that to Communication Services (which includes AI “hyperscalers” Google and Meta) and we’re at 46% of the market’s primary benchmark for just those two sectors, up from about 30% pre-ChatGPT’s launch in 2022. The S&P 500 is organized based on a company’s market capitalization (value) so index returns get skewed by larger weightings. For example, AI-related stocks generated nearly all of the S&P 500’s return of about 3.5% in September.

Also lifting the spirits of investors during Q3 was a progression of generally positive economic news followed by a highly anticipated interest rate cut by the Federal Reserve in September. The cut was pretty much a given but there was some doubt because inflation was still above the Fed’s target and the economic outlook was favorable (September GDP surprised to the upside, rising at an annualized 3.8% vs 1.5% expected). However, labor market weakness was the main reason offered for the Fed’s rate cut. Investors ended the quarter expecting multiple quarter-point rate cuts from the Fed going into 2026 even though there’s low risk of major slowing or recession in the months ahead. This would, at least in theory, act as additional tailwind for the economy and markets.

Expectations for lower rates helped drive the yield on the benchmark 10yr Treasury note from about 4.5% in July to nearly 4% during September before climbing back to almost 4.2% as Q3 ended. Falling yields mean higher bond prices so this helped fuel the 2% return for core bonds mentioned above. This also helped reduce the average rate on a 30yr fixed mortgage to around 6.3%, which led to an uptick in purchase applications across the country. This pent-up demand was good to see given how much the wealth effect impacts consumer spending. We also learned that average home equity is at multi-decade highs. That might sound reminiscent of the Great Financial Crisis but homeowners have a mortgage on about 27% of their home’s value, according to Bespoke Investment Group. (Average mortgage debt was over 80% in 2007.) That’s just an average and home equity doesn’t help consumers who rent, but it helps support consumption for those who do, especially as interest rates fall.

So Q3 was a good quarter during a good year, but what does that mean going forward? Taking a contrarian view is prudent here. Numerous analysts suggest that we may only be in the middle of the game when it comes to AI’s development, and that could keep fueling returns for a while but how long is anyone’s guess. The economy is doing reasonably well, with positive indicators seeming to match or even outweigh negative ones. This could also last a while assuming rates continue moving down in the months ahead. Taken together, it’s a good situation that grows precarious as values rise and parts of the market get overextended, or more so depending on one’s perspective.

This type of environment cries out for incremental rebalancing. If you’re retired, trim from your winners to help fund your lifestyle, pay down debt, add to your emergency fund, buy some bonds, or all of these. If you’re still working and saving, keep it up but get prepared for volatility – it’s just a question of when and what the catalyst will be, and it will create opportunities for smart and patient investors.

Another theme for rebalancing is to consider incrementally moving some of your broad market-cap weighted holdings into equal-weighted funds to reduce your exposure to overheated sectors. One popular index fund from Invesco (ticker symbol RSP) that equal-weights the S&P 500 members contains only 17% in Tech and 5% in Communications Services as of this writing. Swapping a portion of a cap-weighted fund with something like this in your IRA or Roth IRA would be an easy way to diversify without near-term tax impacts. I may do something like this on your behalf if I'm managing your portfolio.

Have questions? Ask us. We can help.