Q3 2025 MARKET REVIEW: STRENGTH AMID SHIFTING EXPECTATIONS

U.S. markets continued their upward trajectory in the third quarter of 2025, fueled by solid corporate earnings, resilient consumer spending, and a growing belief that the Federal Reserve may soon shift to a more accommodative policy stance. While risks remain, investor sentiment stayed broadly optimistic as equities hit fresh highs and AI momentum kept driving key sectors forward.

Equity Markets: Broad Gains with Tech and Small-Caps in Focus

Major U.S. equity indices were higher in Q3, building on strong momentum from earlier in the year. The S&P 500 and Nasdaq notched multiple record closing highs, with the most recent coming on September 22, while the Dow Jones Industrial Average closed the quarter at an all-time high. Small-cap stocks also had a standout quarter. The Russell 2000 rose 12.0%, its best performance since Q4 2023, hitting a record high on September 18. This resurgence suggests renewed investor confidence in the broader economy, especially among domestically oriented companies. Within large-cap tech, performance among the "Magnificent 7" was mixed. Leaders included Tesla (+40.0%) and Nvidia (+18.1%), while Meta (+0.5%) and Amazon (+0.1%) lagged. Notably, the equal-weighted S&P 500 returned +4.4%, underperforming the cap-weighted index’s +7.8%, reflecting the growing concentration of market gains among a few mega-cap names.

Fixed Income, Commodities and the Dollar

Treasury markets firmed over the quarter, with the yield curve flattening as shorter-term yields declined. The shift came amid increasing expectations for rate cuts by the Fed, driven by signs of a cooling labor market and the potential for softer economic data ahead. The U.S. dollar (DXY) rebounded slightly, rising 1.0% in Q3 after a sharp decline in the first half of the year. Gold delivered another stellar quarter, up 16.8%, bringing its year-to-date gain to 46.7%, as investors sought safety and potential inflation hedges. Oil prices, however, softened—WTI crude fell 4.2%—despite an unsettled geopolitical backdrop and continued production adjustments by OPEC+.

Macro Themes: The Fed, Labor Market and Inflation

A key theme for Q3 was a noticeable shift in Federal Reserve expectations. What began as forecasts for a slow and shallow easing path evolved into growing consensus around multiple potential rate cuts by year-end. While not all Fed voices are aligned, the dovish tone has become more pronounced. Labor market data showed early signs of softening. While June’s jobs report was strong, July brought a miss and significant downward revisions to prior months. August hiring was tepid, though the unemployment rate stayed low and jobless claims remained relatively stable. Inflation remained a concern. Core PCE, the Fed’s preferred gauge, stayed above the 2% target. Several Fed officials flagged ongoing upside risks, though Chair Powell indicated he views the inflationary impact of new tariffs as likely short-lived.

Consumer Resilience—and Caution

Despite economic crosscurrents, consumer spending remained firm. Control-group retail sales saw healthy gains, and travel demand was strong over the summer. However, there are growing signs of strain, especially among lower-income households. "Trade-down" behaviors are increasing, and even higher-income consumers appear more cost-conscious. Sentiment surveys show cautious optimism, with purchasing plans intact but concerns rising about job security and inflation persistence. Consumer health remains a key pillar for the economy—and a potential inflection point should labor market conditions deteriorate further.

Policy and Geopolitical Developments

Trade policy was another area of focus. The 90-day pause on reciprocal tariffs expired on July 9, leading to a mix of new deals and fresh unilateral tariffs effective August 1. Another 90-day pause is now in effect through November 10, with a possible Trump–Xi meeting on the sidelines of the APEC summit in South Korea next month. Meanwhile, an August court ruling questioned the legality of certain tariffs enacted under emergency authorities. While this creates uncertainty, the administration retains alternative legal tools to implement its trade agenda.

Earnings and Corporate Trends

Second-quarter earnings exceeded expectations across most sectors. Companies cited rising input costs due to tariffs, but many were able to offset these through mitigation strategies, including passing costs on to consumers. Looking ahead to Q3, earnings are expected to remain strong, helping support market valuations. Corporate activity also saw a boost, with an uptick in M&A and continued retail investor engagement, both of which added to bullish market sentiment.

AI Momentum and Benchmark Concentration

The AI theme remained a major market driver, lifting sectors from semiconductors and cloud infrastructure to utilities and power generation. Optimism remains high, although challenges around monetization and competitive pressures are beginning to attract more attention. The surge in AI-related names has contributed to benchmark concentration risks, with the "Mag 7" stocks now making up over 35% of the S&P 500’s market cap—a key trend for investors to monitor heading into Q4.

Looking Ahead

The third quarter’s rally was supported by a "path of least resistance" narrative: resilient economic data, strong earnings, and growing expectations of Fed easing. Optimism around AI, steady consumer activity, and renewed small-cap strength added further fuel. However, risks remain on the horizon. Labor market softness, inflation persistence, and ongoing trade policy uncertainty could all pose headwinds in the months ahead. Additionally, the Fed’s messaging has grown more mixed, which could introduce volatility if expectations for policy easing shift. As we move into the final quarter of 2025, staying balanced—acknowledging both the tailwinds and the potential challenges—will be key for investors navigating the next phase of this evolving market cycle.

What River Wealth is Doing

With the backdrop of significant gains concentrated in Tech and AI, we see diversification and quality as increasingly important factors to consider in portfolio construction. Should sentiment or results around AI shift, markets are poised for a significant correction. In this scenario, positions that have lagged the recent market rally are likely to outperform and provide some protection in a down market. Periodic rebalancing and trimming positions that have experienced outsized gains are important means of reducing overall volatility in portfolio returns. In markets like today’s, portfolios left unattended will experience concentration risks that exacerbate losses when markets turn. We work daily to balance portfolio risk management with participation in extraordinary market performance.