The Quarter in Review | 3Q 2025
AI EXCITEMENT AND FED CUTS SPUR STRONG STOCK RETURNS
Stocks posted strong returns for the third quarter as the Russell 3000 Index gained +8.18%. The Federal Reserve made its first rate cut of the year at its September meeting and signaled openness to further rate cuts before the end of 2025. While the quarter ended with the U.S. headed toward a government shutdown, the market made gains going into the end of the quarter, with major U.S. stock indices posting positive returns for each month during the third quarter.
Technology stocks outpaced other sectors during the quarter as continued excitement around artificial intelligence (AI) drove stocks like NVIDIA to reach new all-time highs. The NASDAQ Composite Index returned +11.41% for the quarter. While technology’s dominance has been a trend over the course of this year, the third quarter also saw strong returns for small cap stocks, which had lagged earlier in the year. The Russell 2000 Index was up +12.39% for the third quarter, outpacing large cap stocks.
While globally stocks were up, U.S. gains outpaced other developed markets with the MSCI World ex USA IMI Index (net dividends) returning +5.60% for the quarter. Emerging markets outpaced developed stocks as the MSCI Emerging Markets IMI Index (net dividends) rose +9.88%. With the exception of this quarter, non-U.S. markets overall are outpacing the U.S. market’s gains year-to-date with the MSCI All Country World ex USA IMI Index (net dividends) up +25.97% year-to-date while the Russell 3000 Index is up +14.40%.
FIXED INCOME
The Federal Reserve cut rates for the first time this year and projected more rate cuts this year and into next. However, there’s a wide dispersion among Fed projections. Recent Fed commentary has suggested that the Fed may continue to cut rates if there’s continued weakness in the labor market. Rate movements and bond prices have an inverted relationship – think of it like a teeter-toter, when rates go DOWN, bond prices go UP. Therefore, at a high level, rate cuts tend to be positive for overall bond performance.
Short-term U.S. treasury bonds returned +1.17% while intermediate-term U.S. treasury bonds returned +1.26%. Short-term corporate bonds returned +1.62% and intermediate-term corporate bonds returned +2.04%. The U.S. Aggregate Bond index returned +2.03% for the quarter and is up +2.88% over the last year.
ALTERNATIVES
Metals (precious and industrial) rallied to boost the commodity index, with gold hitting record highs and silver jumping to levels not seen since 2011. Coffee and Silver were the best performers, up +27.68% and +27.28% respectively. Energy-related commodities struggled with natural gas lagging as the worst performer, down -19.03%. Overall, the Bloomberg Commodity Total Return Index returned +3.65% for the quarter. U.S. Real Estate Investment Trusts (REITs) also experienced gains, up 5.09% for the quarter.
ECONOMY
Due to the government shutdown, the most recent employment report we have is from August and it delivered a sobering message on the job front: the economy added just 22,000 jobs in August and the unemployment rate rose to 4.3% from 4.2%. August’s job report also included a downward revision to June, which showed the U.S. economy lost 13,000 jobs that month—the first negative employment month since December 2020, ending what was the second-longest period of employment expansion on record. The four-month moving average showed gains of just 27,000 jobs a month. Other signs of weakness in the labor market are declining quit rates and surveys showing workers say it’s harder to find jobs. In addition, for the first time since 2020, there are more unemployed people (7.4 million) than job openings (7.2 million).
Yet there’s a compelling counternarrative emerging. Despite slowing employment growth, the economy expanded at a solid 3.0% pace in the second quarter. This divergence points to an encouraging trend: rising productivity, potentially driven by adoption of artificial intelligence.
New business formation has surged significantly since the 2024 election, reaching its highest level in almost 20 years. The economy may be more resilient and adaptable than traditional metrics may lead us to believe.
In addition to new business growth, corporate balance sheets are generally healthy, with many companies having locked in lower rates and extended maturities during the previous low-rate environment. The banking sector is particularly well-capitalized, with Tier 1 equity at major banks reaching record highs. Capital at the 20 largest U.S. banks grew by more than $175 billion over the past three years, bringing Tier 1 common equity to nearly $1.3 trillion.
AI IMPACT
Since late 2022, productivity growth has accelerated notably. Second-quarter productivity increased at a 2.4% annual rate, suggesting workers are becoming more efficient, according to Larry Swedroe, author and leading investment advocate. While several explanations exist—from increased work-from-home flexibility to entrepreneurial dynamism—he suggests the most promising explanation centers on technology and AI advancement.
From software development to scientific research, and healthcare diagnostics to supply chain optimization, AI tools are already demonstrating the ability to amplify human capabilities. When productivity rises rapidly, the economic pie grows faster. Companies can produce more with the same inputs, wages can rise without triggering inflation, and tax revenues increase even without raising rates.
Swedroe’s view is that the AI revolution also promises spillover effects. As companies deploy AI tools, they discover new applications and business models. Then the innovation cycle becomes self-reinforcing. Higher productivity leads to more investment, which funds more research, which drives further productivity gains.
AI INVESTMENT
The rate of capital investment in AI initiatives has been nothing short of astounding. The slide below from HEDGEYE shows combined capital expenditures by the “Hyperscaler” group of companies (Apple, Amazon, Google, Microsoft, Meta, Nivida, Oracle and Tesla). In 2023 Q2, total capital invested was $40Billion. In 2025 Q2 – only two years later – it is exceeding $100Billion. That is a quarterly figure, so the annualized amount is over $400Billion of capital investment.
With these massive capital AI-related investments, the question keeps getting raised, are we in an AI bubble?
Lead Edge Capital recently provided some real perspective on this, which we found insightful:
“The nuanced response isn't popular in the media, but it coincides with every other major capital investment cycle in history. The railroad buildout in the 1860s burst in the 1870s, resulting in nearly 25% of the Railroad companies going bankrupt, but it also set the stage for the Robber Baron era where industrialists such as Andrew Carnegie, John Rockefeller, JP Morgan and others built some of the most dominant businesses in American history. Similarly, the fiber optic network buildout in the 1990s ended with bankruptcies at Enron and WorldCom and a 75% reduction in the Nasdaq, while also paving the way for the internet boom that followed.
During these major periods of innovation, investors typically presume the companies creating the most societal benefit will also be the ones that capture the most economic value for their shareholders. While this makes sense in theory, it is often not the case in practice. The biggest winners that emerged from the railroad buildout weren't the railroad companies, which overbuilt and were both capital intensive and competitive, but instead it was the steel and oil empires of Carnegie and Rockefeller that were built on the backs of the new railroad infrastructure. Similarly, the biggest winners from the fiber optic buildout weren't Worldcom and Enron, nor were they the survivors in Verizon or AT&T, who continue to fight bitterly to this day. Instead, the major winners were the internet and software companies that were built on top of this new infrastructure.”
This time though the players involved have extremely strong financials with deep wells of capital to invest. Even if they “miss” on some of their AI endeavors, the odds are a number of their investments will pay off in both the short and long term. We do seem to be in the early innings of the next great technology cycle, we will see where it leads us.
LOOKING FORWARD
As the Government shutdown appears to be over as of this writing, working through the nuances of restarting the Government begins and will take time to get it back up to speed. Because the shutdown started after the third quarter ended, its impact will not be showing up in the economic data for a month or two.
As typical with most periods, current data supports both optimistic and cautionary viewpoints:
The Optimistic Case: Productivity gains, strong corporate balance sheets, and reduced recession risk suggest a maturing, efficient economy capable of continued expansion without overheating. In addition, stronger GDP growth fueled by higher productivity, can help prevent the U.S. debt-to-GDP ratio from rising—addressing another investor concern
The Cautionary View: Employment deceleration, potential consumer spending weakness due to tariff-driven higher inflation leads to economic downturns creates downside risks.
While short-term market movements remain unpredictable, especially during periods of policy transition and uncertainty, maintaining discipline and focus on long-term objectives continues to be a reliable approach to investment success. During these times, commitment to disciplined investment management becomes even more important.
Maintaining discipline – adhering to long-term investment strategies rather than emotionally reacting to short term volatility.
Systematic rebalancing – methodically buying into market declines and trimming positions that may have run up.
Tax-loss harvesting – identifying opportunities to realize losses in taxable accounts that may offset gains and potentially reduce tax liabilities.
SUMMARY
Perhaps more so than in recent memory, the road ahead appears more ambiguous and tumultuous than ever. Thankfully, none of us are traveling this road alone. Uncertainty, tumult, rebounds, gains – they are all part of the investor’s journey. And, like every quarter, we’ll say it again because it bears repeating – this is where time we spend with you up front in developing your investment plan pays dividends in the long run.
We appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.
As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we would be happy to discuss with you.
Please follow this link to read the complete Quarterly Market Review (QMR) - 3Q 2025.