Domestic Equity Market Commentary – 3Q 2025

Domestic equities picked up where they left off the prior quarter, with three consecutive months of gains, bringing the winning streak to five months since the April Liberation Day meltdown. Stronger than expected corporate earnings, broadly solid US economic data, resilient consumer spending, continued aggressive AI investment spending, and the first of several expected Fed rate cuts were the primary drivers behind the market’s advance. The S&P 500 gained 8.1% for the quarter, pushing year-to-date performance to 14.8%. The S&P 500’s gains were relatively narrow, with Magnificent 7- and AI-heavy sectors of Information Technology, Communication Services, and Consumer Discretionary the only three of 11 market sectors to beat the Index.

The Russell 2000 Index of small cap stocks posted an impressive 12.4% gain in the quarter, pushing year-to-date returns back into the double digits at 10.4%. Unlike large caps, returns were much broader among small caps, with eight of 11 sectors posting double-digit gains. Record gold prices had the mining stocks within the Materials sector leading the way, with economically sensitive and AI-heavy sectors of Industrials, Communication Services, and Information Technology not far behind. More speculative names in industries such as nuclear power, quantum computing, cryptocurrencies, and fintech were also very popular among retail investors, again making lower-quality style factors such as non-earners, low ROE, and high beta the strongest parts of the market.

Growth stocks dominated returns among large caps, with Growth beating Value by 5.2%, and extending the year-to-date lead to 5.6%. Yet among small caps, Value held a small 0.4% advantage over Growth given the breadth of the rally across economic sectors. However, small cap Growth still maintains a 2.6% advantage over Value year-to-date.

The outlook for the economy and the stock market appears better than many expected. Corporate earnings have outpaced Wall Street forecasts, driven by robust AI-related investment and resilient consumer spending, even as confidence surveys remain soft. The impact of tariffs, the big concern earlier this year, has also been quite muted, as companies have found ways to mitigate their impact on both demand and profitability. ISM surveys also show a continued expansionary services economy, albeit a still sluggish manufacturing economy. Lastly, the Fed has finally resumed its path of rate cuts in September, expected to aid in economic growth, with several more cuts expected later this year and into next. The sluggish labor market and somewhat sticky inflation remain the primary fears of market pundits, although neither is yet deteriorating in a manner that would derail the economy.

Uncertainty over the duration and impact of the government shutdown will likely keep the market on edge, especially with stocks sitting near all-time highs. With Trump at the helm, it is near impossible to predict how this shutdown will play out. One must recall that the longest prior shutdown took place under his watch during his first administration. Corporate balance sheets remain healthy, providing ample firepower for share buybacks, dividends, and acquisitions. Personal balance sheets also remain strong, no doubt helped by record stock market levels, providing a continued tailwind for spending and investment.

As we move into fall, we turn our attention to 2026. Despite the strong market, the valuation of the S&P 500 has remained steady, as market advances have been offset by earnings growth expectations that could reach double digits in 2026. We remain committed to building portfolios of well-run companies positioned for long-term success that sell at reasonable valuation levels. Market participants, especially retail investors, however, have been focused on a narrower set of more speculative growth companies, willing to pay almost any price for this growth. This is not to say the next generation of corporate success stories won’t be found from among these names; just that there is a price above which favorable returns will be difficult to achieve. No doubt this can be a challenge for long-term, quality-oriented investors like us, but it does not change our belief that our clients will be best served by our approach over time.