Q3 2025 Market & Economic Outlook

 

Current Economic Views

 

Despite facing multiple headwinds for the first half of 2025, the U.S. economy logged a slow-but-steady performance. Government policy was cloudy, and geopolitical challenges also surfaced.

 

Some of the concerns from the first half of the year subsided somewhat. Some trade progress is happening, and Middle East conflicts (which can potentially impact oil prices) have eased. Also, the One Big Beautiful Bill Act provided some clarity on tax policy.

 

The labor market remained sound, with unemployment low at 4.1% and the economy averaging about 130,000 new jobs per month this year. Inflation, measured by the Consumer Price Index on a year-over-year basis, improved to 2.4% in May compared to 2.9% in December.

 

The housing market is still slow amid affordability issues. Inventory remains tight, although it has improved recently. Mortgage rates averaged close to 7% for the year’s first half. Most homeowners still have rates of 4% or less, which is impacting inventory. The manufacturing sector remains stalled, with industrial production roughly flat this year.

 

With some risks subsiding, recession fears are down a tad. Bloomberg’s recession probability recently declined to 37.5% from 40%.

 

Globally, most economies “muddled through” trade tensions. In Europe, unemployment remains near record lows at 6.2% and central banks have lowered rates to boost consumption. In addition, Europe (Germany in particular) announced stimulus measures, including spending on infrastructure and defense. The unemployment rate in Japan also remains low at 2.5%, although with inflation rates above target (recently at 3.5%), stimulus from its central bank is unlikely. China, the world’s second-largest economy, remains committed to achieving 5% GDP growth. Despite a low unemployment rate of 4.5%, Chinese domestic demand is still weak.

Looking ahead

We expect the U.S. economy to continue progressing, albeit with slow consumption growth. As tariffs impact the economy, households could tighten their belts.

 

The Federal Reserve expects inflation to tick up a bit; however, where tariff levies end up will play a large role in price growth.

 

The tax-and-spending bill clarifies tax policy in future years. The bill includes incentives for business spending, which could provide a boost heading into 2026 and beyond.

 

While trade negotiations remain ongoing, there is some progress. The effective tariff rates will likely rise, but should be manageable for the overall economy. Depending on which industries are impacted the most, winners and losers will emerge. Consumers may substitute the price of higher imported goods with less spending on services.

 

We expect job growth to continue, but at a slower pace. There are still more job openings than job seekers, which should lead to job growth in the second half of this year. The private sector needs to stay healthy since federal job cuts are underway.

 

With the global economy moving past “peak tariff fears,” growth should continue overseas.

Current Investment Views: Equities

 

After April’s rough start, equities bounced back, with the S&P 500 touching all-time highs and up roughly 10% for the quarter. The Nasdaq Composite was also up over a whopping 15% for the quarter. Large tech stocks exposed to artificial intelligence drove the markets.

 

There are signs of division within the Magnificent 7, and we could see a new set of stocks drive the markets forward. For example, Nvidia was up about 40% during the quarter, while Apple was down about 10%. (Both companies are part of the Mag 7.)

 

While we still see strong performance from large-cap tech stocks, the divide between some of them is getting stark. Past performance does not promise future results, and the markets constantly change based on expectations that can vary frequently.

 

Several geopolitical events during the quarter impacted equity markets. Early in the quarter, the Red Sea crisis caused global shipping fleets to reroute, which increased risk, costs, and delays.

 

Conflict arose between Israel and Iran, which exacerbated issues in the Middle East, with the major impact happening in the oil and energy markets. The outlook appeared rather grim, with oil (energy) being a large cost for many companies and essentially all shippers. Tensions have cooled down a bit, and the potential for a wider conflict has somewhat subsided.

 

Many end-of-year estimates put the S&P 500’s fair value between roughly 5,800 and 6,200. The wide range of outcomes shows just how many possibilities there are for the future on many issues. However, market participants still think the index can end the year in positive territory since the average consumer and job market are in fairly good shape.

Looking ahead

The market’s reaction to the One Big Beautiful Bill Act has been muted so far since the core framework was largely anticipated.

 

Overall, we are seeing improvements in the balance of risks within the markets, which is a big reason the S&P 500 recently hit new levels. Some trade deals are getting done, tensions in the Middle East are improving, and Federal Reserve rate cuts are likely in the year’s second half. Optimism is increasing, but that sentiment is fragile.

 

Tensions in the Middle East will remain a key factor. Early indicators show cooling tensions, but unfortunately, a reversal can happen suddenly and unexpectedly. If hostilities flare up, the impact will most likely occur in the oil markets, likely increasing inflation. How wide a potential conflict spreads will be a determining factor in how much oil prices increase.

 

Tariff uncertainty continues to linger in investors’ minds and will continue to impact markets and their outlook. Uncertainty surrounding growth, federal policies, consumer sentiment, and inflation all influence market dynamics.

 

The constantly changing environment leaves businesses unsure of how to proceed, which stifles investment, as it is unknown whether the investment can generate positive returns.

Current Investment Views: Fixed Income

 

For the quarter, the 10-Year U.S. Treasury Yield rose a mere two basis points, ending at 4.23%, and the 2-Year U.S. Treasury Yield declined 16 basis points to 3.72%. This yield curve steepening occurred because, at least in this case, the fixed income market expects a rate cut soon but is also more hesitant about holding longer-term U.S. debt.

 

Reasons for the market’s views include:

 

• The economy began to show signs of slowing due to the uncertainty of the Trump administration’s approaches. Also, monetary policy was restrictive.
• Investors became increasingly confident that low second-quarter inflation and the slowing economy would provide better odds for cuts soon.
• Longer-term U.S. Treasuries saw their term premium (the excess yield investors demand for holding longer-term bonds compared to rolling over a series of shorter-term bonds) rise to the highest levels in over a decade. Volatile trade policies increased the perceived risks of holding longer U.S. debt. Concerns also mounted over the nation’s debt issues.

 

Credit spreads (the excess yield investors demand for holding a corporate bond instead of a similar U.S. Treasury) narrowed as the hard economic data largely held up and tariff fears subsided to a degree. Credit spreads are well below historical averages, signaling the bond market currently sees little reason to worry about the economy.

 

Fed-funds futures (market-based data points used to project monetary policy changes) priced in roughly 67 basis points of cuts to the Federal Reserve’s benchmark rate by the end of the year, reiterating the market thinks cuts are coming soon.

Looking ahead

While Fed Chair Jerome Powell thinks the central bank is in a good position to adjust depending on the incoming economic data, its positioning is getting more worrisome since the economy is slowing, but inflation will likely creep higher.

 

The nation’s debt (heightened by the One Big Beautiful Bill Act’s passage) is an issue. It is uncertain how much tariff revenue will offset the potential for continued deficits. Most Fed officials prefer waiting for greater tariff clarity and/or signs of material labor market weakening before resuming cuts.

 

In the Fed’s latest economic projections, the median real GDP growth projection for 2025 decreased to 1.4% from 1.7%. The Fed also lowered the 2026 median projection.

 

The central bank’s median core PCE inflation projection for the end of the year increased to 3.1% from 2.8%, mainly reflecting the tariff effects. Inflation estimates in later years were also revised higher as policymakers worried about some lasting price pressures.

 

The median unemployment rate projection for 2025 year-end was revised to 4.5% from 4.4% to reflect slowing growth. Proceeding year projections also increased.

 

The median projection for two quarter-point rate cuts in 2025 was unchanged, although one cut was removed for 2026.

 

The landscape can shift quickly, particularly as more policy changes occur.

Asset Spotlight: Dividend Equities

 

The equity markets were highly volatile during the first half of this year. How volatile? Based on historical price volatility data, the early second quarter was among the most volatile of the last decade, with only the early stages of the COVID-19 pandemic topping it¹.

 

Tariff policies and geopolitical tensions contribute to the uncertainty in the markets and the economy. Numerous scenarios could happen, which is partially why dividend payers are appealing.

 

Many (not all) dividend payers are in mature industries and have more consistent free cash flow generation – albeit with the tradeoff of typically slower potential growth. This element of stability can be beneficial in times of elevated market uncertainty and volatility when market participants prefer the relative safety of more consistent earnings streams. In this environment, investors also may place a premium on the tangible return of capital versus speculation on future growth.

 

While the Federal Reserve cut rates last year, we are still in an elevated rate environment. In a higher rate environment, borrowing is more expensive, and companies that can self-fund capital needs and return capital to shareholders have value.

 

Some (again, not all) dividend-paying equities have pricing power. Western Union (part of our dividend strategy) is a good example. The financial services company has some pricing power because its size allows it to send money to more locations than competitors.

 

Dividend stocks also appreciate well in many cases. The S&P 500 High Dividend Index’s (SPXHDUP) five-year price appreciation is currently about 52%, or 8.8% on an annualized basis. Also, the SPXHDUP’s five-year total return was 91% when dividends were reinvested.

Looking ahead

Dividend-paying equities are a part of many of our strategies. Some of our principles include:

 

• Looking for dividend sustainability, both in terms of willingness (management showing a track record of paying dividends) and ability (adequate interest coverage at reasonable dividend payout ratios) to continue honoring their dividend commitments. 
• Looking for dividend growth so inflation does not erode the real payment over time. 
• Researching companies that trade at a discount to intrinsic value. This valuation discipline is often reflected in above-market dividend yields. 
• We assess security volatility by considering each company’s contribution to the total portfolio risk.

 

Volatility and uncertainty will likely continue. President Trump often has a pro-growth business agenda, but is frequently prone to whiplash decision-making.

 

Companies are pausing investment decisions because of economic uncertainty, which is slowing growth.

 

Taking reliable, quality (and not always flashy) positions is often prudent in times of volatility and uncertainty.

 

 

¹ The metric we are referring to is 30-day price volatility, stated as the annualized standard deviation of the relative price change for the 30 most recent trading days. Essentially, it measures the magnitude of day-to-day stock price movements.