Q4 2025 Economic & Market Outlook

“Every picture tells a story, don’t it?”

By Scott Welch, CIMA®, CEPA®, Chief Investment Officer & Partner

Reviewed by Carter Mecham, CMA®, IACCP®

After a remarkably complacent summer and early fall, the economy and markets seem to be bracing for much more uncertainty in Q4.

The potential issues abound: geopolitical tensions, a government shutdown, uncertainty over trade and tariff policies, uncertainty over future Fed policy decisions, and a seemingly “stretched” global equity market are all factors investors are trying to decipher as we head toward the end of the year.

When reviewing the current state of the global economy and investment markets, we always recommend focusing on market signals and weeding out market noise. We believe the five primary economic and market signals that provide perspective on where we go from here are GDP growth, earnings, interest rates, inflation, and central bank policy. 

This is not to dismiss national, political, or geopolitical issues. But these are “known unknowns” – we are aware of them but have no way to forecast how they will turn out or what effects they will have (or not) on the economy and investment markets.

As we write this, these “known unknowns” include (1) the longer-term effects of Trump’s tax, regulatory, and tariff policies; (2) ongoing geopolitical tensions (we certainly hope for the best in the recently announced peace plan between Israel and Hamas); and (3) the longer-term effects (if any) of the current US government shutdown.

With this as the backdrop, let’s “drop in” on where we stand and where we might go from here.

GDP, Inflation and Central Bank Policy

Let’s start with the yield curve (i.e., interest rates), specifically two closely watched “spreads”: the 10-year / 2-year spread (10s/2s) and the 10-year / 3-month spread (10Y/3M) spread.

As a general comment, the yield curve has been relatively “docile” for most of the past three years, with both the short and long end trending downward in response to Fed policy (both actual and anticipated) and a generally resilient but cooling economy, respectively.

The yield curve, as measured by the 10s/2s remains (slightly) positive and upward sloping – that is, “normal”.

The 10Y/3M spread indicates a remarkably flat overall curve, however, with only eleven basis points (0.11%) separating the 3-month rate from the 10-year rate. Investors are still not being rewarded for taking on excessive duration risk.

Source: Ycharts, 3-year data through October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

As expected, the Fed chose to cut rates by 25-bps at its September meeting, and the consensus is that it will cut again at its October meeting and then (perhaps) again in its final meeting of the year in December.

There is uncertainty regarding these potential rate cuts, however. First, with the government shutdown, the Fed may be making decisions in the October meeting with a lack of economic data.

If the shutdown continues through the meeting dates (October 28-29), we believe the Fed will cut anyway, since that was its (non-consensus) “signaling” following the September meeting.

If the Fed does cut, it will cite a cooling economy and labor market as the catalysts – it will not cite inflation, which remains stubbornly above the Fed’s targeted 2% annualized rate and, in fact, is trending in the wrong direction.

Put differently, the Fed, to some degree, is between a rock and a hard place. If it does not cut in October or December, not only will it infuriate the market (and Donald Trump), but it also runs the risk of putting additional pressure on an already cooling economy and labor market.

If, on the other hand, it acts as expected and cuts rates at least once more this year, the markets will be happy and the economy should benefit, but the risk is rising inflationary pressures that may force the Fed to “retreat” back to raising rates sometime in 2026.

There are no easy paths forward at this time.

Source: The Atlanta Fed “Market Probability Tracker,” as of October 8, 2025. These are forecasts and therefore subject to change.

Unemployment remains below 5% – historically, the level considered “full employment” for the US economy.

Source: St. Louis Fed (FRED), 5-year data through August 2025.

We see a slight trend upward in “continuing” jobless claims, but “initial” claims have proven to be remarkably resilient. The way to interpret this is that workers who have jobs are not losing them (initial claims) but people who have lost their jobs are finding it increasingly difficult to find new ones (continuing claims).

We use the 4-week moving averages of these numbers to smooth out the weekly volatility.

Source: St. Louis Fed (FRED), data through September 13, 2025.

There are other signs of a “cooling” in the labor markets – job openings, hires, and quits are all trending downward. The quits rate is interesting because it is an indication of how confident employees are that they can find better work elsewhere if they leave their current positions (so a downward trend means less confidence).

Source: St. Louis Fed (FRED), 5-year data through August 2025.

Inflation is trending in the wrong direction and remains above the Fed’s targeted rate of 2% annually. This is one reason the Fed is in somewhat of a pickle with respect to rate policy.

Furthermore, note that the Producer Price Index (PPI) – the cost of inputs to manufacturers and other producers of goods – is rising and has now matched the consumer inflation metrics.

So far this year, any inflationary effects from tariffs have been muted by (a) producers stockpiling inventory prior to the April “Liberation Day” announcements, and (b) producers choosing to “eat” the rising costs of inputs and not pass them through to consumers in the form of higher prices. How much longer can this last?

Source: St. Louis Fed (FRED), 5-year data through August 2025.

The current median Q3 GDP forecast is 2.4%, with 2-3 outlier forecasts skewed to the upside. The estimated Q2 GDP growth rate was recently increased from 3.3% to 3.8% – the economy continues to chug along.

Source: The Capital Spectator, as of October 10, 2025. These are forecasts and subject to change as additional data come in.

Longer term, the Fed is still forecasting modest growth for the remainder of 2025 and for the next several years (first chart). Remember that the Fed is notoriously bad at accurately forecasting future GDP growth rates, but it is helpful to know what they are thinking.

Likewise, the Fed “dot plot” signals that a majority of members anticipate 1-2 more rate cuts this year.

The outlier “lower rates” dot is undoubtedly the newly appointed member Stephen Miran, who was hand-selected by President Trump to be an open advocate for lower rates (second chart).

Source for both charts: The FOMC “Summary of Economic Projections,” as of September 17, 2025. There is no guarantee that any projection, forecast, or opinion will be realized. Actual results may vary.

Estimates for economic growth outside the US are muted but positive, and roughly in line with historical averages.

Source: BNP Paribas, as of October 6, 2025. There is no guarantee that any projection, forecast, or opinion will be realized. Actual results may vary.

Earnings and Valuations

The Q3 2025 earnings season will begin shortly, and the consensus estimates call for another solid quarter after a strong Q2. Revenues and earnings are expected to be solid well into 2026.

Note that earnings are expected to increase through 2025 and into 2026 despite relatively flat revenue projections – the market seems to be pricing in significant productivity gains, perhaps due to accelerating applications of artificial intelligence (AI).

To date, those productivity gains are hard to see – outside of the mega-cap tech stocks, industry surveys indicate dissatisfaction among CEOs, as they are not yet realizing the productivity gains they anticipated and/or they are finding it harder to implement than they thought.[1]

Source: Zacks Investment Research, as of October 8, 2025. Green bars are earnings and orange bars are revenues. Solid bars are actual results, while hatched bars are estimates and, therefore, subject to change.

Outside the US, earnings growth estimates are positive. Even China is expected to show earnings growth as the result of significant monetary and fiscal stimulus from the Chinese government.

Source: The JP Morgan “Guide to the Markets,” as of September 30, 2025. Earnings growth estimates are forecasts and subject to change. Past performance is no guarantee of future results.

Despite the outperformance of non-US stocks throughout this year, global valuations remain more attractive outside the US (though the S&P 500 index valuation remains skewed upward by the mega-cap tech stocks), but the global equity rally over most of the past 12-18 months has resulted in few, if any, “screaming buys” across the equity spectrum. There may be some slight relative value in both US and non-US small cap stocks.

Source: Eaton Vance, “The Beat,” October 2025. You cannot invest in an index and past performance is no guarantee of future results.

Within the US, the mega-cap tech stocks continue to dominate, and correspondingly drive the valuations for large cap stocks upward overall. Interestingly, a current media focus is on whether or not we are approaching an “AI bubble.”

We explored this question more deeply in a recent blog but, in summary, we think “not yet,” but we are paying attention.

Source: Yardeni Research, as of October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

If we dive a little deeper into other asset classes and styles, we notice several things.

1. Small cap stocks have been marked by a decided “junk rally,” whereby the lower quality Russell 2000 index has far outstripped the higher quality S&P 600 index, with valuations reflected accordingly. Regardless of this short-term outperformance, we remain committed over the longer-term to a quality bias within our portfolios.

Source: Ycharts: YTD data as of October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: Yardeni Research, as of October 2, 2025. You cannot invest in an index and past performance is no guarantee of future results.

2. We see a similar performance and valuation dispersion between US large cap growth and value stocks.

Source: Ycharts: YTD data as of October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: Yardeni Research, as of October 2, 2025. You cannot invest in an index and past performance is no guarantee of future results.

3. And, despite the non-US outperformance this year (partially due to a steadily decling dollar), we see similar valuation differentials between US and non-US markets.

Source: Ycharts: YTD data as of October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: Yardeni Research, as of October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Interest Rates and Spreads

We discussed the level and shape of the curve above, but what about credit spreads?

Credit spreads remain extremely tight by historical standards, and we believe any future pressure is upward, not downward. Corporate balance sheets remain (generally) in solid shape, though there are signs of increased delinquency and default rates.

Despite the recent decline in rates, we don’t believe rates will remain as low as their current levels, and that general market pressure will eventually return to upward rather than further downward, barring an unexpected economic or geopolitical disruption. As such, we continue to hold modest expectations for the total return potential of public bonds.

Given the shape of the yield curve, investors are still not being appropriately compensated for taking excessive duration (interest rate) risk.

We continue to recommend balancing fixed income exposures between the two in a “barbell” approach as a means of generating acceptable levels of yield while controlling duration risk.

Rather than diving into public high yield, we believe investors seeking higher yield are better served by accessing the private credit space.

Source: Ycharts, data through October 9, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Summary and Interpretation

When focusing on what we believe are the primary economic and market signals, the “condition our condition is in” is generally positive, with uncertainty regarding trade and tariff policies, unclear economic and inflation trends, future Fed policy, and continuing geopolitical tensions.

To summarize our investment views for the remainder of 2025 and into 2026:

• We believe global equity markets can maintain their positive sentiment, but valuations are becoming worrisome, especially in the mega-cap tech stocks. While not necessarily calling for a market disruption, we would not be surprised to see market corrections if interest rate, inflation, economic, or earnings news come in worse than expected.
• We believe the total return potential for public fixed income is muted. We continue to favor balancing short-term and longer-term allocations to manage duration risk without sacrificing too much yield. We prefer investment grade versus high yield bonds at this point in the economic cycle. Investors seeking higher yields should consider the private credit market versus bank loans or public high yield bonds.
• Fundamental and strategic asset class rotation investors should look at the relative value attractiveness of US value and non-US allocations. We are bullish longer-term on both value and smaller cap stocks, but it may be too early to make that reallocation trade just yet.
• Active management and intelligent risk factor tilts should be rewarded versus passive management. 
• We continue to like the private markets for those investors who can access them. Larger cap direct middle market private credit lending may be getting “crowded” due to heavy investor inflows, but more opportunistic market niches continue to present interesting opportunities.

• Specific private equity segments – secondaries, energy infrastructure, sports investing, real estate, and GP stakes – seem to be offering more interesting opportunities than the traditional spaces of growth equity and M&A.

• We maintain an active search for multi-strategy hedge fund solutions, as we believe the market regime going forward is favorable for lower correlated and more diversifying strategies.

• As always with alternative and private market investments, manager selection is critical to longer-term success.

Our overall asset allocation guidelines can be summarized as follows – we are in a fairly “low conviction” frame of mind right now.

Source: Certuity, as of September 30, 2025. Evaluations are subject to change as market conditions change. This is for illustration purposes only and does not represent investment advice. All evaluations are on a relative and not absolute basis. Red = a negative relative evaluation; gray = a neutral relative evaluation; green = a positive relative evaluation. You cannot invest in an index, and past performance is no guarantee of future results.

As philosophically strategic investors, we continue to recommend focusing on a longer-term time horizon and the construction of “all-weather” portfolios, diversified at both the asset class and risk factor levels.

We hope you find this helpful and, as always, we welcome your feedback and questions.

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[1] MIT report: 95% of generative AI pilots at companies are failing | Fortune