Markets Continued Their Rally
Global risk markets maintained their positive trajectory through the end of the third quarter. In fact, broad indexes for U.S. stocks, international stocks, many cryptos and even core fixed income were all up single digits. Gold even rallied double digits for the quarter despite having been mostly flat from mid-2020 through early-2024.
The markets can be quite humbling – both in their ability to flush out inefficiencies as well as work through seemingly difficult circumstances to ultimately move onward and upward.
We currently face an environment where stock market valuations have rallied strongly while many important variables remain uncertain: the rule of law is being questioned across a number of subject matters, global geopolitics are strained, and massive investments are being made into artificial intelligence (AI). And yet, the broader markets have continued their strong ascent towards new highs despite a challenging start to the year when U.S. equity markets were down double digits this spring. But, markets consistently experience setbacks along the way – it is worth noting that markets on average experience at least one 10% pull back from their highs during the year, yet long term investor returns are still meaningfully positive on a full-year basis. Such is the ebb and flow of how markets evolve!
International markets have continued their strong rally and have continued to outpace the U.S. through the end of the third quarter. International developed markets are up 26% for the year (MSCI EAFE ex-U.S.) while emerging markets are also up 28% (MSCI Emerging Markets). A material component of this return is due to the U.S. dollar depreciation which has helped prop up these international returns from a U.S. investor perspective. It’s unclear if that tailwind may continue in any material form going forward, but with the heightened uncertainty in the U.S., international participants have begun to recalibrate their expectations.
There are always laggards, but it’s hard to find a broad sector or market that hasn’t seen a strong 2025 across a range of categories. The rally has broadened to other areas of the economy from U.S. technology – including to international market opportunities – but as an investor looking prospectively, it’s difficult to determine if those themes and market breadth can continue.
Read on as we explore the market uncertainty, the current interest rate environment, and inflation.
Market Uncertainty
U.S. risk assets and markets appear to be trading at levels that discount the likelihood for things to go wrong. I.e. many companies are priced such that the AI revolution can evolve profitably and successfully and geopolitical conflicts (and tariffs) will be sorted out with minimal disruption. At current levels, if those expectations are not met, then that can potentially create short-term downward pressure on stock prices. That is not to say that a near-term correction is imminent or that downside HAS to occur, just that the scales could quickly tilt toward near-term disruption if the economy and markets deliver anything but positive news. So, in an environment like this, it is important to remain balanced and diversified, so you can position yourself to not be a forced seller if markets see their next setback. However, it is important not to lose sight of the long-term picture that is overwhelmingly positive over decades.
While pricing is at heightened levels in the U.S., particularly across large cap and mega cap companies, we are merely at the same price-to-earnings levels that markets were hovering around at year-end 2024 despite the choppy ride we’ve experienced during 2025.
While many eyes are on big U.S. technology names, the massive amount of funds chasing AI opportunities are showing up in the form of earnings in corporate profits among the beneficiaries of that growth (think AI technology providers, chip makers, data centers, etc.).
Free cash flow for big technology names in some cases are close to being exhausted, so they may potentially need to lean on other ways to finance continued expenditures in the AI space. One thing that is quite different from many prior cycles is that these big technology names generate so much cash flow that they have largely been able to manage even these massive expenditures from their own cash flow to date. One question that remains to be addressed is if those AI investments can translate into real returns and profits. A possible path could be a reduced need for hiring going forward which could also help corporate expenses and their bottom line since one of the largest expenses on companies’ financial reports are their people. However, fewer workers hired does have its own implications for the strength of the economy and working class.
A broader question lingers regarding how quickly AI has evolved and what the implications are for entry level staff. How are people supposed to progress over time in their careers and develop if they have struggles being able to secure the basic training ground they need to get to higher level thinking, tasks, and job functions?
Thinking critically and not outsourcing that component of what we do to AI may help – the brain is a muscle and needs to be exercised too – but it’s up to each person to help use the tools as tools for the right reasons and to help prevent “bad players” as possible.
Interest Rates
The Fed reduced rates by 0.25% this quarter and the market expectations are set to see another one or two cuts before year end. This can potentially help translate to lower financing costs, but the uncertainty on whether inflation can/will accelerate is keeping rates potentially higher than they otherwise could be. That being said, we do not expect rates to drop to the zero-bound levels seen in the post-2008 Global Financial Crisis.
Inflation is recently impacting less volatile components of the economy than it has in the recent past – “households’ rising estimates for one-year ahead inflation are not being driven by expectations for higher prices for volatile items like food and gas—as was the case during the pandemic. This increases the risk that inflation expectations will remain above the Fed’s 2% goal” (Source: Bloomberg). Seeing less volatile components of the economy with inflation may prove a challenging headwind for household spending.
With tariffs remaining a significant variable, it is currently unknown how impactful they will be to U.S. companies and consumers. Many businesses – particularly small and medium sized businesses NOT in the technology space – are struggling to manage pricing and expectations for their products. It can be difficult to manage through an environment like this when it is unclear how/when tariffs will go into effect, whether they will be increased (or decreased) and on what timeline as well as where to properly get the data needed on what tariffs are currently in place. Thus, the question remains if the impact of tariffs may be a one-time adjustment to the pricing level vs. what may be sustained headwinds to face. History in this situation is not a reliable roadmap for how things will play out, but over most historical periods an increase in tariffs tends to show the costs end up being borne by the party imposing such tariffs.
Both gold and cryptocurrencies have propelled in the current year, and the story of being inflation hedges is still debatable. In the COVID crisis that began in 2020, neither behaved as people expected when seeking an inflation hedge. And, in the face of a doomsday scenario, gold is unlikely to provide a reasonable mechanism for transacting with someone (or a business) since it would still need to be converted to some kind of currency. The jury is still out on whether crypto could serve that purpose. Particularly with how volatile cryptocurrencies have been, it does not currently serve as a reliable store of value despite being near-record high prices. I.e. if you were paying in cryptocurrencies when you go to the grocery store, the cost of bread and milk could be orders of magnitude different from one day, week or month to the next which does not create enough pricing stability to reliably transact in those currencies on a day-to-day basis still.
With an administration that seems to be pro-cryptos, there is some near term support, but it would be ill advised to assume that will without-a-doubt continue beyond the current administration – it may, but future regulatory changes can also be very disruptive to existing players. As that space has evolved, stablecoins could become key, but there is much to watch for whether any of those can/will prove concept too. And, regulatory changes (often overnight) can be very humbling to entire industries.
Closing Remarks
With companies that can “hyperscale” given today’s lower barriers to entry for technology, the trend of a company completely skipping the small-cap and mid-cap space and jumping right to large-cap can be feasible if the company can survive the “proof-of-concept phase”. AI is lowering the barrier to entry in a lot of industries and spaces, and we would largely anticipate that trend to continue. Just like any new technology, it is important to carefully weigh the pros and cons, and buildout proper checks and balances to try and prevent unintended downstream effects for years to come.
When it comes to investing, the key, as always, is to remain diversified – create the structures your situation needs, and align your investments with your cash flow to be able to weather the storms that come. But, just like the weather often changes patterns or shifts unexpectedly, so too can the tides of investment preferences. Building resilience into your long-term plan that can allow you to adjust in real time through maintaining cash reserves, reducing speculative bets, and just simply being nimble can help you potentially build and retain that wealth over the long-term.
By taking the appropriate level of risk and creating that optionality in your financial plan, you can better remain calm in times of market distress, and attempt to avoid being put in a position to be a forced seller. Having a plan in place during difficult times can often allow you to instead be opportunistic when others are panicking. Accomplishing your goals over time requires discipline and intentional tools such as maintaining a healthy emergency fund, planning around taxes and/or short-term obligations (typically as we define anything with a 12-18 month or less time horizon), and not investing irreplaceable capital into speculative investments.
Positive, bull markets tend to meaningfully outperform bear markets, and there is a more than 100 year history of that being the case – the U.S. economy is resilient despite very challenging environments that have existed. By focusing on the long-term picture, you can often avoid the pitfalls of the near-term negative barrage of information. How might your decision making be reframed if you were to think of how those decisions are amplified over the long-term? Taking just one step, then another, then another, amounts to walking a significant distance over time despite the rocks, streams, and obstacles you may have to traverse along the way.