GW&K Investment Review 3Q 2025

ECONOMIC COMMENTARY

The stock market continues to rise in spite of the steady stream of negative headlines around presidential policies. Maybe, just maybe, it is rising because of all that press? An old adage is proving true: “Markets climb walls of worry.” Why? Because when investors are fearful of “what comes next,” they tend to hold back, leaving more money uninvested, as we are seeing today.

As the market continues to rise, those same skeptics begin to invest until they are fully committed, at which point the market is vulnerable to a serious correction.

I don’t need to detail the sources of angst in the market and in the whole system. What I want to discuss is why the stock market is rising. As I see it, there are three basic forces propelling it: First, the level of interest rates; second, the AI revolution, and third, the sense that capitalism is regaining ground.

When it comes to interest rates, there is little doubt that short-term rates will likely decline over the next two years. When and how fast is impossible to predict, but the stock market only cares about direction, and the direction for short-term rates is down. Many believe long-term rates stay elevated, pointing to inflation and large federal budget deficits. But I believe that view misses a critical factor: psychology. The Federal Reserve lowering short-term rates signals concern for the economy, which in turn stokes fear of recession or stagflation. Yes, the economy is slowing, which is why long-term rates should also move lower. Any decline in long-term rates would benefit housing as well as the smaller businesses that rely on bank debt. If short-term rates fall 2% over the next two years, long-term rates would likely drop by 1%. Both moves could stimulate growth and help steer the economy away from recession.

The AI revolution is in the first inning. We can’t yet grasp its full significance. We can see the vast sums of money being invested, but the efficiencies to come are beyond our ability to evaluate. What we should realize is that AI will bring significant changes to the workforce, accelerate profit margins, and in turn boost corporate earnings. Past economic transitions have reshaped industries and careers—many of our parents’ jobs no longer exist. Even in our time, the shifts have been tectonic. Jobs will change, opportunities will emerge, but differently. Most importantly, productivity gains from AI will be deflationary, pushing down costs for consumers and lifting margins for businesses. It would be a mistake to underestimate AI, despite the disruptions.

Finally, government regulation. Recognizing the need for oversight, we also know regulation has gone too far—at the city, state, and federal levels. Efforts may be well-intentioned, but the result has too often been to slow progress. I am not capable of parsing which rules are useful and which are not, but I do know that the overall burden is heavy. Greater efficiency on this front would help economic growth.

So, while the political environment feels unsettled, there are real positives at work. We are not naive enough to say all is well, but we do recognize that all is not bad. Try to see the good that is happening and maintain an optimistic outlook.

Harold G. Kotler, CFA