In this latest installment of our newsletter, we share our observations of the markets and the economy in the third quarter of 2025. Click here to go to the full report on our website. Following are the highlights:
- Stocks registered another record quarter during the three months ended September 30th, posting their strongest third quarter performance since 2020. The S&P 500 Index hit 23 record highs during the period, among the most ever in a single quarter.
- The S&P 500 Index posted a total return of 8.1% and the Nasdaq returned 11.2% in the third quarter, which came on the heels of double digit returns in the second quarter for both indices. Year-to-date through September 30th, the S&P 500 has delivered a total return of 14.8% and the Nasdaq has returned 17.3%.
- Bonds also posted gains, with the Bloomberg Barclays Aggregate Bond Index returning 2.0% in the third quarter and 6.1% year-to-date
- Momentum built throughout the quarter as market volatility remained unusually low. Investor sentiment was lifted by resilient corporate earnings, continued optimism around artificial intelligence (AI), and expectations for a new cycle of monetary easing. All of these positives played out despite ongoing concerns about tariff and trade policies, slowing labor conditions, and geopolitical crises around the world.
- Technology and communication stocks once again drove the rally, however a strong showing by industrial, financial, and materials stocks fueled a more broad-based market rally in Q3 than has been seen for quite some time. For the first nine months of 2025, all eleven sectors of the S&P 500 Index have generated positive returns.
- The Federal Reserve announced its first interest rate cut of the year at its September 17th meeting, cutting its benchmark short-term rate by one-quarter of 1% (or 25 basis points) to a target range of 4.0% – 4.25%. This marked the first rate cut since December 2024 and was largely prompted by a softer-than-expected August jobs report. The move was seen as a measured step to support economic growth, by balancing concerns about inflation with the need to support the labor market.
- The U.S. economy has been sending somewhat mixed messages, with strong GDP growth counter-balanced by a slowing labor market. U.S GDP grew at a better-than-expected annual rate of 3.8% in the second quarter of 2025, according to the final estimate of the U.S. Bureau of Economic Analysis. For the third quarter ended September 30th, the forecasts for GDP growth range from 3.9% (the Fed’s GDPNow model) to 2.5% (the New York Fed’s projection).
- Another bright spot in the economy has been corporate earnings, which have continued to grow at a solid clip so far this year. Year-over-year earnings of the S&P 500 Index grew by 11% in Q2 and are expected to grow by nearly 8% in Q3, which would be the ninth consecutive quarter of earnings growth for the index.
- But not all the economic news is this optimistic, with the U.S. labor market starting to show some cracks. The August unemployment rate rose to 4.3%, up from 4.2% in July, as a modest 22,000 jobs were added during the month. The unemployment rate has shown a steady uptick since June, when the rate stood at 4.1%. Persistently weak hiring since the spring has contributed to the uptick, but the lack of mass firings has also kept a lid on unemployment.
- Consumer confidence also fell in September due to growing worries about the labor market. And fears about inflation re-igniting continued to play out in August. The Consumer Price Index (CPI), the broadest measure of inflation, increased by 2.9% year-over-year in August 2025, up from 2.7% in July. Elevated costs for food, shelter and services contributed to the increase.
- Adding to the uncertainties, Congress failed to pass a continuing resolution to fund the government beyond midnight on September 30th, causing the government to shut down. Prolonged shutdowns can impair economic activity and reduce government revenues and spending. However, financial markets have historically treated shutdowns as a short-term disruption, triggering a typical “risk-off” reaction. That means that volatility can rise, the dollar may fall, and stock markets can sell-off. But the depth of a sell-off tends to mirror the length of the shutdown, with markets bouncing back quickly once government operations are restored.
- Looking forward, we are somewhat cautious on equities in the near term given the economic, fiscal, and geo-political uncertainties. We also consider the broad market to be fairly valued, based on the S&P 500’s current forward price-to-earnings ratio of approximately 22.5 times, just above its 5-year average of 20 times.
- However, we believe that many parts of the market warrant valuations higher than historical averages based on factors like technological progress, productivity advances, and asset-light business models that have produced consistently higher profit margins and free cash flow for a large number of companies in the S&P 500 Index.
- In addition, not all segments of the market carry lofty valuations. For example, many healthcare, energy, and financial stocks are trading substantially below the market’s average P/E multiple, and we continue to look for opportunities in these and other undervalued sectors.
- Overall, we continue to favor more value-oriented, dividend-paying stocks that have strong cash flow characteristics, leading market share, a wide economic moat, and solid growth prospects.
- While we still own 6-12 month Treasury bills with annualized yields just below 4% for excess cash, we are on the lookout for additional income securities as those Treasury yields decline.
- We continue to emphasize to our clients the importance of sticking to a long-term investment plan focused on their specific goals and objectives. We believe our patient, disciplined approach to individual security selection offers our clients strong, long-term return potential in a transparent, cost effective, and tax efficient manner.
- We appreciate your confidence in our time-tested investment philosophy, and we remain steadfast in our commitment to helping our clients and their families reach their long-term financial goals.
The Edgemoor Team
