US equities continued their strong run in the third quarter, with the S&P 500 closing at record highs after gaining 8.12% for the period and 14.83% year to date through September 30. The rally was supported by strong earnings, optimism around AI infrastructure, resilient consumer spending, and growing confidence that interest rates have peaked. Still, elevated valuations, a cooling labor market, and early credit stress suggest a more cautious outlook is warranted.
MARKET RECAP
During the third quarter, the S&P 500 notched 23 new all-time highs—more than one in every three trading days. After dropping 19% earlier this year, the S&P 500 has since surged 35% from its April 8 low through September 30, making the brief bear market feel like a distant memory.
While US markets continued their impressive run, diversified investors also benefited from broad strength across major asset classes. Highlights through September 30 include:
- Small caps outperformed large caps, gaining 39% for the quarter.
- Growth and technology stocks led the way, with large-cap growth up 51%.
- Value stocks lagged growth but still posted a solid 33% return.
- International developed markets trailed the US for the quarter but remain ahead year to date, up 14% in 2025.
- Emerging markets gained 64% for the quarter, led by China, bringing year-to-date returns to 27.53%.
- Bonds were generally positive, with the Bloomberg US Aggregate Bond Index up 03% for the quarter.
- Gold extended its rally, rising 36% for the quarter and 46.61% year to date—on pace for its best year since 1979.
Echoes of the Late 1990s
While broader markets remain strong, enthusiasm has returned to select pockets of speculation. Since the April 8 market low, groups such as unprofitable tech, AI-related names, meme stocks, and heavily shorted companies soared—some by more than 100% in just a few months. These sharp gains underscore renewed risk appetite but also warrant caution before investing new money.
This enthusiasm echoes the late 1990s, when optimism over new technologies fueled a powerful but ultimately unsustainable rally. While today’s leaders—companies like Nvidia, Microsoft, Apple, Amazon, and Alphabet—are far stronger and more profitable than those of the dot-com era, valuations across several measures have again reached lofty levels.
When we talk about “high valuations,” we’re usually referring to measures like the price-to-earnings (P/E) ratio, which compares a company’s stock price to its profits. Elevated P/E ratios mean investors are paying more for each dollar of earnings—often reflecting optimism about future growth. While optimism can support strong markets, it also leaves less room for error if growth slows or earnings disappoint. In today’s market, valuations are above long-term averages, suggesting future returns could be more modest than what we’ve recently experienced.
Even great companies can become poor investments when bought at excessive prices. The lesson from past bubbles is not that transformative technologies such as artificial intelligence fail to deliver—they often do—but that markets tend to price that promise too quickly. The challenge for investors is to balance excitement about innovation with a sober view of what’s already priced in.
A Softer Dollar Boosts Global Returns
Remaining disciplined doesn’t just mean being selective within US equities—it also means maintaining diversification across regions and asset classes. While high valuations and concentrated leadership warrant caution domestically, opportunities abroad have quietly strengthened. A softer US dollar has provided an additional boost to global investors this year, amplifying returns from developed and emerging markets and reinforcing the benefits of global diversification even when US markets dominate headlines.
Economic Backdrop: Resilience with Hints of Moderation
The US economy continues to show steady, if modest, growth supported by resilient corporate earnings and firm consumer demand—helping sustain elevated stock prices as we enter the final quarter of the year. Economic activity is expected to expand roughly 2–3% above inflation in the third quarter, with spending holding up despite some signs of strain.
The Federal Reserve cut interest rates at its most recent meeting, and markets anticipate further reductions through year-end and into 2026. Still, several risks warrant attention, including shifting fiscal policy, renewed tariff pressures, a softening labor market, and emerging credit stress in the automotive sector.
Monetary policy remains a key focus. As shown in the chart below, investors continue to expect the Fed to lower rates into 2026. However, the Fed has signaled patience, emphasizing the need for continued progress on inflation before easing too aggressively. While a gradual path of rate cuts could support valuations and investor sentiment, the transition is unlikely to be perfectly smooth—data surprises or renewed inflation pressures could still trigger bouts of volatility along the way.
When the Fed cuts interest rates, it’s essentially trying to make borrowing cheaper to keep the economy moving. Lower rates can encourage businesses to invest and consumers to spend—whether that’s companies expanding or families buying homes or cars. For investors, rate cuts often give markets a lift because they can boost profits and make stocks more appealing relative to now lower-yielding cash investments. Still, easier money isn’t a cure-all; if rates stay low for too long, it can fuel inflation or push asset prices beyond fundamentals.
Consumer Spending Remains Resilient
Household spending has continued to grow at a steady pace as consumers travel, dine out, and spend on services. This resilience has been a defining feature of the current cycle, sustaining overall economic momentum even amid higher borrowing costs. However, much of the strength has come from higher-income households, while lower-income consumers have shown more strain as savings diminish and credit balances rise. Data from Morgan Stanley and Bloomberg show that retail and food service sales have been expanding at an annual rate of 3–5%, underscoring the consumer sector’s continued strength.
Weakening Labor Market
Even so, some indicators suggest the pace of growth may be cooling. While the headline unemployment rate remains low at 4.3% as of August, other data point to a softening labor market. The August jobs report showed a gain of just 22,000 payrolls, well below the 123,000 monthly average earlier in the year. In addition, a large downward revision erased about 911,000 previously reported jobs from the prior year. Excluding the healthcare sector, this marks the first instance of negative job growth in 25 years outside of a recession.
Government Shutdown Adds Another Layer of Uncertainty
The ongoing government shutdown has added a new wrinkle for markets and policymakers. Historically, shutdowns have had little lasting impact on market performance, as most government spending resumes once an agreement is reached. However, the longer a shutdown lasts, the greater the potential drag on economic activity—from delayed paychecks to postponed federal contracts. It also complicates the job of investors and economists, as many key government reports are paused, making it harder to assess the economy in real time.
Debt Concerns: Subprime Auto & Auto Parts
Recent reports highlight concern over lax lending standards following the sudden collapses of subprime auto lender Tricolor Holdings and auto parts supplier First Brands Group. These bankruptcies point to early stress in credit-sensitive corners of the economy. While such cases remain isolated, they serve as reminders that tighter credit conditions tend to expose weaker balance sheets first—often late in the cycle, when the easy-money phase has passed. It remains to be seen whether similar pressures will surface elsewhere in the economy.
ROEHL & YI’S FINAL THOUGHTS
As 2025 winds down, markets remain supported by steady growth, resilient earnings, and optimism around artificial intelligence. Diversified investors have benefited from broad strength across asset classes and a softer US dollar. Still, elevated valuations, a cooling labor market, and emerging credit risks suggest that caution is warranted.
Looking ahead, maintaining balance and discipline will be key. Quality companies, global diversification, and a focus on valuations should help investors navigate what may become a more uneven market environment. While enthusiasm for innovation remains justified, history reminds us that patience and selectivity often prove most rewarding late in the cycle.
As Warren Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.” That advice fits today’s environment well—staying disciplined and level-headed when optimism runs high.
Consider these four steps as we enter the final quarter:
- Trim appreciated positions and manage risk thoughtfully.
After a strong market rally, it may be wise to take some profits and ensure your portfolio isn’t carrying more risk than intended. That said, avoid an “all-in or all-out” approach—staying invested with proper balance is usually more effective than trying to time the market.
- Prepare for volatility and review your cash needs.
With the S&P 500 at record highs, a short-term correction would not be unusual. Now is a good time to confirm you have sufficient cash or short-term reserves to cover upcoming expenses, so you’re not forced to sell investments during periods of market weakness.
- Revisit your fixed income allocation.
As the Federal Reserve continues to lower rates, yields on money market funds and short-term bonds are likely to decline. Investors may benefit from extending duration modestly and owning a diversified mix of higher-yielding intermediate bonds, including both municipal and taxable options.
- Stay diversified and mindful of valuations.
Diversification across asset classes, styles, and regions remains essential—especially as US stock market leadership becomes increasingly concentrated. A balanced approach helps reduce risk and capture opportunities wherever they arise.
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Disclaimer: This material is intended for general informational purposes only, and should not be construed as legal, tax, investment, financial, or other advice. It does not consider the specific investment objectives, tax and financial condition or needs of any specific person. An investor should consult with their financial professional before making any investment decisions. While information in this content comes from reliable sources, no guarantee of accuracy or completeness is provided.