Quarterly Investment Research Note – October 9th, 2025

Market Review Summary

• The S&P 500 extended its run during the 3^rd quarter, reaching new highs and producing a +14.83% return year-to-date through 9/30/25.  The quarter was marked by renewed leadership from Growth stocks in the US, particularly those tied to AI infrastructure, cloud and software.¹

• The Federal Reserve resumed rate cuts in September, although taking a cautious approach and labeling the policy change as “risk management.”  The market is now priced for further easing and expected lower rates have heightened optimism for risk assets. 

• International stocks were again positive in the 3^rd quarter and continue to outperform their US counterparts for the year, boosted by a weakening US dollar and a rotation to relatively cheaper geographies.  The outperformance is broad-based around the world with the MSCI EAFE Index returning +25.14%, the MSCI Emerging Markets Index +27.53% and the MSCI World Ex US Small-Caps +29.54% for the year through 9/30/25.²

• The S&P 500’s 22.8x forward P/E is pushing cycle highs.  The top 10 companies in the index make up nearly 40% of the total weight, leaving investors increasingly exposed to the outcomes of those few large companies.  Those top 10 companies trade a 29.9x P/E vs. 19.5x for the remaining S&P 500 stocks.³

• Analysts pared 2025 S&P 500 earnings growth assumptions in the first half of the year but this reversed in the 3^rd quarter; the market is now on pace for +10.4% earnings growth for the year.   Forecasts for 2026 anticipate an acceleration to +13.8%.  Robust and sustained earnings growth continues to provide the core foundation behind the S&P 500’s multi-year advance.⁴
• The bond market has performed well during 2025 and returned +2.03% for the quarter, bringing its year-to-date total return to +6.13% through 9/30/25.  The benchmark 10-year Treasury yield fell from 4.58% to begin the year to 4.16% as of 9/30/25.  Falling short-end yields have caused the yield curve to steepen throughout the year.  The 2-year Treasury yield fell from 4.25% to begin the year to 3.60% as of 9/30/25.⁵

• Corporate credit spreads currently trade at historical tights across collateral types.  The current yield-to-worst on the Bloomberg US Corporate Investment Grade and Bloomberg US Corporate High Yield indices are 4.8% and 6.7% respectively, roughly half of the average spread vs. Treasuries.⁶

• The economy technically shrank in the 1^st quarter due to a large spike in Net Imports front-running tariffs but that reversed in 2^nd quarter, with Real GDP expanding by 3.8% according to the latest estimates.  The seemingly annual recession concerns have faded as the year has progressed.⁷ 

Equity Markets 3rd Quarter Review

The S&P 500 rose +8.1% during the 3^rd quarter.  Risk assets rallied alongside the familiar tailwind of AI-infrastructure enthusiasm and falling rates.  The Dow Jones Industrial Average returned +5.67% for the quarter and is up +10.47% through 9/30/25.  The growthier NASDAQ Composite returned +11.41% for the quarter and is up +17.93% through 9/30/25.  Markets powered higher despite concerns about stretched valuations and fundamentals surrounding the AI theme, ongoing trade and fiscal policy uncertainty, and a softening labor market.⁸

In August, the Federal Reserve telegraphed imminent rate cuts at its Jackson Hole meeting highlighting the balance of risks between employment and inflation and in September, followed through, adding to the appetite for stocks, particularly Small-caps.  The Russell 2000 led broad indices, returning +12.39% for the 3^rd Quarter after being down modestly during the 1^st half of the year.⁹

Growth stocks, specifically in the Technology and Communication Services sectors, led Large-Caps but gains were widespread across styles and market capitalizations.  10 out of 11 economic sectors in the S&P 500 posted positive returns with only negative returns from Consumer Staples.  Energy, Utilities and Industrials stocks all had standout quarters.¹⁰ 

For the year, Technology and Communication Services led, producing +24.51% and 22.31% respectively through 9/30/25.  Industrials and Utilities are also notable outperformers, returning to +18.38% and +17.69% respectively for the same period.  Each sector is positive for the year through 9/30/25.¹¹

Tariffs and trade negotiations remained in the headlines but market reaction has become muted to the subject.  Trade deals have been slow to materialize, although some progress has been made and firms have seemingly adjusted to the current environment.  During the 3^rd Quarter, the US Court of Appeals affirmed the lower court’s decision that many of the reciprocal tariffs exceeded presidential power.  The Supreme Court will hear the case, with arguments beginning next month.  The outcome will determine whether the executive branch retains broad authority to impose unilateral tariffs or whether Congress must explicitly authorize such measures, leaving trade policy a major policy wildcard heading into year-end.

International stocks returns slowed in the 3^rd quarter after a stellar first half but were still strongly positive.  Developed markets, as measured by the MSCI EAFE Index, returned +4.77% and are up +25.14% on the year.  The MSCI Emerging Markets Index was up +10.64% in the quarter and are up +27.53% through 9/30/25.  China was the best performing international market during the 3^rd quarter.¹²

Both currency appreciation and multiple expansion have contributed to the relative outperformance of International stocks vs. their domestic counterparts providing the diversification benefits that have largely evaded balanced US investors in recent history.  The Nominal Broad US Dollar Index has fallen -7% during 2025¹³, providing a short-term tailwind but the rest of the fundamental story is also constructive for International stocks:

• The P/E multiple for the Eurozone and Emerging Markets have expanded from 12.9x and 12.0x to 14.6x and 14.1x respectively during 2025, signaling an increase in investor sentiment even while the valuation discount against the US remains significant.¹⁴
• Eurozone earnings are expected to rebound sharply, with expected growth of +9.5% in 2026 and +13.8% in 2027.¹⁵
• Many non-US economies are investing heavily in their own productive capacity, creating home-grown demand that supports equity markets independent of US cycles.  These initiatives are lifting earnings, productivity, and long-term growth potential, strengthening the fundamental case for international.

International equities still have structural disadvantages compared to US equities (sector composition, demographics, fiscal policy, regulatory and governance issues, etc.)  but they continue to offer valuation appeal, style and currency diversification and exposure to regional growth themes and warrant inclusion in globally balanced portfolios.

Fixed Income Markets Mid-Year Summary

Bonds saw broad gains for the quarter as rates fell and the yield curve steepened modestly.  The Bloomberg US Aggregate Bond Index returned +2.03% for the quarter and is up +6.13% for the year through 9/30/25.  Longer duration bonds benefited from falling rates on the long end.  Municipal bonds also produced strong performance after being negative in the 1^st half – the Bloomberg US Municipal Index returned +3.00% during the 3^rd quarter.¹⁶

Corporate bonds continued their strong year as spreads tightened further during the quarter, nearing historical lows.  The Bloomberg US Corporate Investment Grade Index has returned +6.88% and the Bloomberg High Yield Corporate index is up +7.22% through 9/30/25.  Preferreds were another notable outperformer, up +4.41% for the 3^rd quarter.¹⁷

The best performing fixed income sectors during 2025 include those issued by foreign governments and corporations, particularly in the Emerging Markets.  The falling US dollar has benefited fixed income issues denominated in other global currencies.   When investing in bonds denominated in local currency (non-US dollar), the investor is exposed to exchange rates movements as part of their total return which is a positive contributor if the US dollar weakens vs. those local currencies.  The US Dollar has fallen roughly 7% vs. a trade-weighted basket of global currencies since its peak in January of this year.

Overall, fixed income has been a strong contributor to balanced portfolio returns with core bonds preserving capital and providing income throughout 2025.  Satellite exposures to credit and international bonds have contributed significantly to total returns in the fixed income portfolio if incorporated due to spread tightening and currency movements. 

Rates were generally range-bound and biased to the downside during the 3^rd quarter.  The 10-year Treasury yield touched just below 4% in September but has settled in around an average yield of 4.26% over the past 3 months.¹⁸

The Federal Reserve delivered a “risk-management” 0.25% rate cut in September, lowering the Fed Funds target range to 4.00%–4.25%.  Policymakers highlighted growing downside risks to the labor market: August payroll gains slowed to just +22,000 jobs and the unemployment rate edged up to 4.3%; while also acknowledging upside risks to goods inflation tied to new tariffs.^19,20

Given that core PCE inflation remains above the Fed’s 2% target at +2.9% year-over-year, the Fed views policy as mildly restrictive. Its latest Summary of Economic Projections points to two additional cuts by year-end, with the longer-run policy rate estimated near 3%, implying scope for further easing in 2026-27. Officials stressed, however, that this month’s move was pre-emptive rather than the start of a full cutting cycle, and they will remain guided by incoming data. Futures markets are similarly pricing in two more cuts in 2025 and a policy rate around 3.00%–3.25% by the end of 2026.^21,22,23

We expect the Fed is not done with the risk-management cut before pausing, as officials gauge the trade-off between a cooling labor market and persistent inflation. Markets appear to be pricing in a more aggressive easing cycle than the Fed is signaling. If employment stabilizes or inflation firms again, the central bank may halt the cuts.  This is all made more difficult with the lack of reliable data due to the ongoing government shutdown.

For equities, the reason behind the rate cuts will matter as much as the cuts themselves:

• Positive scenario: If the Fed can ease gradually without a recession, lower rates should support risk assets and especially small-caps, cyclicals, and value stocks that benefit from easier financing conditions.

• Negative scenario: If cuts reflect a sharply weakening labor market, equity markets may struggle despite lower rates.

U.S. stocks have largely priced in an aggressive easing cycle, so further upside depends on earnings follow-through, not just lower yields. The AI-driven growth theme remains a key swing factor for the major indices.

A weaker U.S. dollar also continues to provide a tailwind for international equities.

In Fixed Income, we continue to favor a bar-bell approach of anchoring portfolios with short-term, high-quality bonds for stability and adding selective duration to benefit if long-term yields decline alongside policy cuts.  Credit spreads remain tight, so we prefer investment-grade exposure over high yield, using active management to capture incremental income while controlling risk. 

We expect market swings to occur and be shaped by policy decisions on trade, fiscal spending, monetary policy, and global geopolitics. The strong run in equities, fueled in part by excitement around AI, has stirred fresh debate over whether valuations are stretched.  To mitigate these risks, we continue to emphasize quality, sensitivity to valuations and pro-active rebalancing in equity portfolios.

To conclude we call back to the base case from the beginning of the year, which stated the fundamentals of the economy and the markets are on solid footing and this is persistent even alongside policy turmoil and higher valuations:

• Moderate economic growth, supported by strong consumer, capital investment and increased productivity.
• Neutral monetary policy with a cautious outlook on future easing.
• Broad-based and strong corporate earnings growth in 2025 and 2026.
• Renewed activity in equity capital markets (M&A and IPOs).
• Intermittent volatility surrounding trade policy that may impact currency exchange rates.
• Range bound but volatile interest rates.
• Low and stable inflation.
• Tight corporate credit spreads.

We will continue to provide commentary on the evolving market dynamics in the 4^th quarter, as always, please reach out to any of our team members with questions or comments as needed.

John Nagle

Footnotes:

1. Morningstar Direct Data
2. Morningstar Direct Data
3. JPMorgan Guide to the Markets as of 9/30/25
4. Yardeni Research
5. Morningstar Direct Data
6. St. Louis Fed FRED
7. St Louis Fed FRED
8. Morningstar Direct Data
9. Morningstar Direct Data
10. Morningstar Direct Data
11. Morningstar Direct Data
12. Morningstar Direct Data
13. Morningstar Direct Data
14. JPMorgan Guide to the Markets as of 9/30/25
15. Yardeni Research
16. Morningstar Direct Data
17. Morningstar Direct Data
18. US Treasury
19. St. Louis Fed FRED
20. St. Louis Fed FRED
21. St. Louis Fed FRED
22. Federal Reserve
23. CME Group FedWatch Tool

The views expressed herein are those of John Nagle on October 9^th, 2025 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This market commentary is a publication of Kavar Capital Partners (KCP) and is provided as a service to clients and friends of KCP solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s investment portfolio. All investment strategies have the potential for profit or loss and past performance does not ensure future results. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The charts and graphs presented do not represent the performance of KCP or any of its advisory clients. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results.  There can be no assurances that a client’s portfolio will match or outperform any particular benchmark. KCP makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that KCP considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and KCP is not obligated to update any information or opinions contained herein. Articles herein may not necessarily reflect the investment position or the strategies of KCP. KCP is registered as an investment adviser and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.