Capital Markets Playbook | Q4 2025

2025 Q3 Summary

• Global equity markets continued to move higher through the third quarter of 2025.
  • Major U.S. large cap stock indices posted gains in Q3 (+7.9%) and finished at, or near, all-time highs.  
  • Despite outperforming international and emerging market (EM) equities in Q3, however, U.S. large cap stocks have greatly underperformed foreign stocks in 2025.
  • U.S. small cap stocks outperformed U.S. large cap stocks, posting strong gains in Q3 (+12.3%). Despite the recent strength, however, U.S. small cap stocks have meaningfully underperformed most equity asset classes in 2025.
• Broad-based fixed income markets were positive in the third quarter of 2025.
  • All major fixed income asset classes have significantly outperformed cash in 2025.
  • Riskier fixed income asset classes (ex: high yield, EM debt) have outperformed more conservative fixed income assets classes in 2025 (ex: Treasuries, investment grade fixed income).

2025 Q3: In Review

Update on Tariffs and Trade Deals

• Further progress on trade deals continued during the quarter as the U.S. announced deals with larger trade partners, including Japan and the European Union.
• The U.S. and China extended the pause on reciprocal tariffs by another 90 days through November 10. Despite these pauses, it is likely that U.S. tariffs on Chinese exports will remain much higher than those imposed on the rest of the world.
• It is unknown whether the reciprocal tariffs that the U.S. placed on goods imported from abroad will be ruled illegal by the U.S. Supreme Court. As of now, tariffs will remain in place as the case awaits Supreme Court appeal ruling. Even if the Supreme Court confirms that the tariffs are illegal, it is likely that the U.S. explores other ways to implement tariffs. This ruling changes nothing in the short term for the Federal Reserve, as it continues to operate under the assumption that tariff policy will remain as it stands.
• Takeaways
  • The fact of the matter remains that the magnitude and timing of any final trade agreements remain to be seen, and volatility may increase as deadlines draw near.
  • The impact of tariffs on U.S. consumer prices continues to be muted to this point, with corporations absorbing the costs of tariffs more than consumers. Assuming a major escalation in trade protectionism does not occur, inflationary impacts from tariffs are expected to be short term and moderate in nature.

Macroeconomic Review

• Economic Growth
  • Following volatile GDP prints during the first two quarters of 2025, economic growth in Q3 looks to be stronger than originally anticipated. Early GDP estimates for Q3 suggest that the U.S. economy could have grown by more than 3%.
  • For the full year of 2025, GDP is expected to be slightly lower than the longer-term trend rate of 2%.
• Consumer Spending
  • Consumer spending picked up during the third quarter, despite expectations for continued deceleration due to the impacts of tariffs.
  • Data is not yet available, but most expect third quarter U.S. consumer spending to be slightly ahead of the longer-term trend growth rate of about 2.5%.
  • Continued lack of clarity around tariffs and trade policy could cause consumer spending to slow in future quarters.
• Unemployment
  • Unemployment, currently at 4.3%, moved up slightly during the quarter. Despite remaining below the long-term average, the Fed acknowledged that job gains have slowed and the unemployment rate has edged up. Weakening labor markets were a key factor in the Fed’s decision to lower rates in September.
• Inflation
  • The inflationary impact of tariffs has yet to be fully reflected across the aggregate U.S. economy. In fact, Core CPI is approximately 0.2% lower than peak levels reported earlier this year.
  • Most economists expect a moderate, temporary uptick in inflation in the months ahead as tariffs continue to filter into the aggregate economy. That said, assuming that new trade deals are announced soon, the prospect of a significant increase in inflation is rather remote.
• Interest Rates and Monetary Policy
  • The Fed lowered interest rates to 4-4.25%, citing a weakening labor market despite sticky inflation. This marked the first rate cut since December 2024.
  • Markets currently expect that the Fed may cut short-term interest rates by an additional 25-50 bps by the end of 2025. That said, if the labor market weakness subsides in the months ahead (and inflation does not decline), it is possible that the Fed decides to keep rates as they are for the rest of the calendar year.
• Partial Government Shutdown
  • As of the end of Q3, Congress could not pass a spending bill to avoid a government shutdown. Government shutdowns are relatively common and tend to be resolved quickly. The longer the shutdown lasts, however, the more likely it becomes that consumer spending and economic growth slow noticeably.

Equity Market Review

• Since the April 8 market low, U.S. small cap equities have outperformed U.S. large cap equities by more than 4%, supported by expectations of a supportive interest rate environment and future earnings growth expectations.
• Large cap equities carried their momentum into Q3, notching 26 new all-time highs over the quarter, an average of two new highs every week.
• International equities trailed domestic equity quarterly returns due to headwinds from global macroeconomic policy and a stable U.S. dollar.

Fixed Income Market Review

• Despite pockets of policy-driven volatility, domestic fixed income has fared well year-to-date, buoyed by stable rates and a relatively unchanged short-term inflation outlook.
• High yield once again outperformed investment grade fixed income in Q3 by approximately 50 bps. In Q3, high yield benefited from the same “risk on” sentiment seen in global equity markets.
• Thanks to a meaningful weakening of the U.S. dollar this year, international fixed income (local currency) has posted very strong returns in the first three quarters of 2025. With year-to-date returns of +7.9% thus far, it is one of the highest for the asset class in nearly three decades.

• International equities gained in Q3, advancing on fundamentals and valuations rather than currency tailwinds as the U.S. dollar held stable.
• The weakening U.S. dollar has provided a significant tailwind for domestic investors year-to-date, amplifying their returns in international markets.
  • The U.S. Dollar Index (DXY) recorded its sharpest first half decline in nearly 40 years, contributing to a notable divergence in year-to-date asset class performance.
• While interest rate differentials and inflation typically influence currency movements, the year-to-date dollar weakness appears more closely tied to concerns over U.S. fiscal sustainability, growing uncertainty around trade policy, and interest rate differentials with other developed markets.

2025: Macroeconomic Expectations

• Unemployment “Base Case”
  • Unemployment remains low relative to historical standards and is expected to finish the year at, or near, current levels of 4.3%.
• Inflation “Base Case”
  • Inflation is expected to increase slightly as impacts from tariffs flow through the economy, keeping inflation levels above the Fed’s 2% target in 2025.
    • Personal Consumption Expenditure (PCE) inflation – the Fed’s preferred measure of inflation – is expected to increase from 2.9% to about 3.1% by the end of 2025.
• Interest Rates “Base Case”
  • The slope of the U.S. Treasury yield curve may steepen as the Fed makes monetary policy more accommodative.
    • Short-term interest rates may be cut by as much as 50 bps before the end of 2025 if the Fed continues its monetary policy normalization effort.
    • Intermediate and long-term interest rates may move higher in the months and quarters ahead, as markets weigh concerns over U.S. debt and deficits.
• Risks to “Base Case” Expectations
  • Unemployment risks
    • Businesses that have avoided job cuts in 2025 due to a “wait-and-see” approach to policy matters may determine that they cannot wait any longer to cut costs.
  • Inflation risks
    • Tariffs on imported goods could push inflation higher, as their impact is still working its way into the economy.
  • Interest rate risks
    • Mounting concerns over U.S. debt and deficits could lead investors to demand higher yields (even if inflation is moving lower).
• Takeaway
  • Slightly higher unemployment, sticky inflation and restrictive short-term interest rates will make it challenging for the U.S. economy to grow at (or above) its long-term trend rate over the next several quarters.

U.S. Equities and Rate Cuts

• Despite inflation remaining stubbornly above the Fed’s target, the Fed prioritized continued economic growth and the slowing job market by cutting the Fed Funds rate 25 bps to 4.00-4.25% on September 17. This was the first rate cut since December 2024. At the time, the S&P 500 was just below its all-time high.
• Since 1985, the Fed has cut rates while the S&P 500 was within 2% of an all-time high on 20 other occasions. In those instances, one-year forward returns averaged 16.3% versus an average annualized return of 9.3% over the time period. Rate cuts near market peaks have historically helped propel additional gains.
• It is important to remember that stock performance during easing cycles is highly dependent on the state of the economy. If the economy avoids a recession, rate cuts should act as a tailwind to increasing corporate investment and profits, which generally boosts returns.
• Takeaway:
  • Even during times of strength, investors remain bullish on equities when the Fed is dovish, and the continued price strength is highly correlated with an expanding domestic economy. 

2025 Potential Policy Changes: Corporate Income Tax Reform

• The One Big Beautiful Bill Act delivers U.S. corporate income tax reform that should serve as a tailwind to boost corporate earnings growth over the short term, as the 21% corporate tax rate could fall to as low as an effective 12% rate – the lowest in U.S. history.
• In addition to increased profit margins, this lower corporate tax burden is likely to support increased capital spending across a number of domestic sectors, as well as the ability to return more value to shareholders via higher dividends and stock buybacks.
• Firms that pay higher effective income tax rates (above 15%) and produce more than 80% of annual revenue in the U.S. stand to benefit the most. Firms that generate more revenue overseas (or already have low effective tax rates) may see little benefit.
• Provisions in The Act also raise interest deduction limits and the permanent allowance of immediate expensing for research and development and short-lived assets. These provisions will serve to increase company cash flows leading to a potential boon for M&A activity.
• Takeaway
  • Firms within Financials, Industrials, Consumer Staples and Consumer Discretionary may benefit the most from corporate income tax reform. 

Long-Term Investors Should Stay Invested

• The chart highlights how a $10k investment in the S&P 500 would have grown over the past 45 years.
  • If the investor missed the best 30 days of market performance, the investment portfolio would be worth more than $1.3M less than if the investor had stayed in the market.
• Takeaways
  • The market’s best performance days typically occur during periods of elevated volatility.
  • Regardless of what may be in store for the macroeconomy and capital markets, long-term investors should avoid the temptation to exit out of markets during periods of elevated uncertainty.
  • Riding out market volatility is the best way to build wealth over the long term.

Equity Market Volatility

• The chart illustrates annual S&P 500 performance since 1980 (shown in columns above) and the intra-year declines during each year (shown by the red dots).  
  • Ex: In 2020, the S&P 500 experienced an intra-year decline of -34% before finishing up 16% for the year.
• Over the past 45 years, the S&P 500 has experienced an average intra-year decline of 14%. Despite that, the S&P 500 had positive annual performance in 34 of the last 45 years.
• Takeaway
  • As painful as market volatility can be, equity market selloffs are normal and investors are rewarded for patience.

Playbook Summary

• The above table indicates where each major investment asset class falls on the distribution of attractiveness (from low to high). This table is meant to provide a standardized and comparable view of the level of opportunity in each asset class category.
• In subsequent quarters, we will discuss any movement along the scale for each asset class and the driving forces behind the change in outlook.