Q3 2025 Market Update: Markets Hold Steady Despite Mixed Signals

The economic trends and capital market returns have generally defied the dire expectations from the start of the year. Many economists and market pundits believed that an erratic tariff policy from the new administration, combined with elevated inflation, would lead to an economic slowdown and below-average returns in the capital markets.

While the unemployment rate has risen modestly, corporate profits remain strong, and economic growth is on pace to grow around 2-3 percent for the year. Further, concerns about high tariffs have yet to materially impact consumer spending or inflation.

Although capital markets were quite volatile earlier in the year as investors wrestled with these issues, markets have since rebounded significantly, and investor sentiment appears strong. Still, it may be too early to declare victory. Several conflicting signs point to the potential for an economic slowdown in certain sectors, while the cumulative effect of inflation is weighing on consumer sentiment and could ultimately impact their spending habits. Time will tell.

Inflation Eases but Job Growth Weakens

On the economic front, while data on the direction of trends is conflicting, the overall tone remains generally positive. First, the rate of inflation, as measured by the Consumer Price Index (CPI), has settled in the range of about 2.5 to 3.0 percent annually. It’s a much better level than a few years ago, but still above the Federal Reserve’s stated mandate of around 2.0 percent and slightly higher than a few months ago. A recent uptick in food, vehicle and energy prices has been the main driver pushing inflation higher. Not surprisingly, consumers’ view of the economy and their outlook have deteriorated as worries persist about the strength of the labor market, combined with rising prices for everyday purchases that are pinching their pocketbooks.

Still, although the unemployment rate has increased from 3.8 percent at the beginning of the year to 4.3 percent today, it remains low by historical standards. However, the monthly new jobs report showed meager growth in August, and over the last three months the economy has added an average of only 29,000 new jobs per month, including significant annual revisions. This marks the weakest stretch of job growth since the pandemic, with the number of people who have permanently lost their jobs rising to the highest level in nearly four years.

Services Show Strength While Housing Stumbles

The manufacturing and services sectors of the economy are also showing conflicting signs, alternating between expansion and contraction. For the past three years, the manufacturing sector has been in a slight contraction, with weak new orders and declining employment reflecting sluggish consumer demand. On the services side, the latest data release showed expansion at the fastest pace in six months, driven by a sharp acceleration in new orders. Twelve services sectors expanded last month, led by information, wholesale trade, and arts and entertainment, while four sectors contracted. Yet, more sustained growth in new orders and demand is likely needed to encourage companies to hire and expand operations.

The housing market is another area that continues to struggle, weighed down by high mortgage rates and elevated home prices. This combination has led to the worst home affordability environment on record, accompanied by very low builder confidence and rising inventory of new, unsold homes. Hopefully, with the Federal Reserve cutting interest rates, mortgage rates should decline and provide some relief for buyers.

Stocks and Bonds Deliver Solid Quarterly Returns

With greater clarity on economic trends along with lower interest rates, both stocks and bonds produced solid returns for the quarter. The S&P 500 Index returned 8.1 percent, while mid- and small-cap stocks posted a 5.5 percent and 9.1 percent return, respectively. Foreign stocks, as measured by the MSCI All-World Index, returned 7.4 percent. The Aggregate Bond Index returned 2.0 percent while corporate bonds returned 2.6 percent for the quarter.

Our Outlook

Looking ahead, strong corporate profits, stable inflation and a resilient consumer should produce modest growth and further gains in the capital markets. However, should the economy slow further, the Federal Reserve will be forced to lower interest rates more aggressively, which could add volatility to both stocks and bonds.

For now, we are generally positive on the growth outlook and expect modest returns for domestic stocks, even though valuations are elevated for many of the large growth names. International stocks continue to shine after many years of underperforming domestic stocks, a trend we expect to persist. In bonds, slightly lower interest rates and moderating growth should help the asset class deliver solid results through the rest of the year and into 2026.