Markets appeared to shrug off mounting economic and geopolitical uncertainties as they continued their upward trajectory. The volatility index (VIX) remained relatively calm while US indexes reached new highs in the third quarter. One explanation for the strong stock market is the expected productivity growth driven by AI and related spending. The largest companies leading this capital spending now represent an increasingly large share of the S&P 500. Job market data from the Bureau of Labor Statistics (BLS) and ADP suggested a softening yet still growing economy with unemployment holding steady at 4.3%.
Fed Chair Powell warned that markets were “fairly highly valued,” and inflation ticked up to almost 3%. The Fed trimmed its policy rate by 25 basis points to a range of 4% to 4.25%, citing cooling economic activity, slowing job gains, and a modest rise in unemployment. Through the years, the Fed has been subject to frequent criticism. Powell continues to assert the Fed’s independence and its dual mandate to contain inflation and promote full employment. If the impact of tariffs on prices is transient, there is more risk to not lowering rates than keeping them higher to fight inflation that remains above the Fed’s 2% target.
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The futures market expects two more cuts for the remainder of the year and two to three next year, and these expectations are supporting the stock market gains. Treasury rates longer than one year declined only slightly with shorter rates matching changes in the Fed Funds rate.
US stock markets[i] returned 8.2% for the quarter. Large stocks slightly underperformed the US market, returning 8.0%. Small cap stocks continued to bounce back from sell-offs earlier in the year, outperforming large stocks and returning 12.4%. Large growth stocks outperformed large value, but small value stocks were the best performing US asset class, returning 12.6%.
Developed international markets trailed US markets in the 3rd quarter with a return of 4.8% while emerging markets outperformed, returning of 10.6%. Non-US small value stocks continued to outperform, although the dollar did not weaken as much during the quarter.
Domestic real estate[ii] ended the quarter with a return of 5.1% while US Utilities[iii] gained 8.0%. Alternative lending posted modest gains over the quarter of 0.6%, while reinsurance benefited from hurricanes staying off the coast of the US and posted a gain 11.9%.[iv]
[i] Large, small, and broad market returns are based on the Russell 1000, 2000, and 3000. Value and Growth are based on the respective Russell indexes. International developed and emerging market equities are based on EAFE and MSCI Emerging Markets indices, respectively.
[ii] Dow Jones US Select REIT Index.
[iii] Utilities are represented by the MSCI US IMI/Utilities Total Return Index.
[iv] Reinsurance and alternative lending represented by Stoneridge Reinsurance Risk Premium Interval Fund (SRRIX) and Stoneridge Alternative Lending Interval Fund (LENDX), respectively.
