2025 4Q Outlook: Shifting Gears

KEY POINTS

Shifting Gears

The Fed pivots: The September rate cut (the first in nearly a year) confirmed the Fed’s shift toward easing (i.e. lowering interest rates). For investors, it reopens the playbook for risk assets and income generation, but selectivity will matter as policy normalizes.
Labor market softness: Hiring momentum weakened, and unemployment edged higher, signaling slower economic traction. This raises the importance of defensive balance in portfolios heading into Q4.
AI investment surges: Artificial intelligence continues to drive corporate spending and market leadership, though valuations demand discipline. Investors should stay long on quality names while trimming excess enthusiasm.
Market breadth expands: Small caps and cyclicals joined large-cap tech in the rally, signaling healthier participation. This rotation supports a more balanced equity approach after two years of narrow leadership.
Year-end positioning in focus: With labor risks rising and valuations stretched, we suggest investors emphasize positioning for income, quality, and selective growth to capture upside while managing volatility.

Staying Ahead of the Curve

Markets don’t move in straight lines – they bend and shift with policy, data, and sentiment. This past quarter was a vivid example of how markets incorporate, react and adjust to every datapoint. The key question on investors’ minds for most of 2025 was when (or if) the Fed would cut interest rates. That answer finally came in September. The immediate reaction was relief, with stocks surging to new highs. Yet while the market is hitting new highs, the economic data beneath the surface suggests increasing risks. Labor markets are cooling, inflation has not fully relented, and fiscal policy uncertainty is far from resolved. All of which is to say investors need to start paying more attention to fundamentals and valuations as they put money to work.

We believe the Fed’s cautious approach, what Powell framed as a “risk management” cut, represents the beginning of a measured easing cycle. That’s constructive for equities and risk assets, but it doesn’t erase underlying challenges. Government dysfunction, as seen in the shutdown standoff, adds another layer of volatility.

Meanwhile, AI has become both a driver of growth and a source of debate – is this going to be a repeat of the late 90s where AI spending ultimately results in a bust? Or is this truly the dawn of a transformative era in technology in business? In our view, it will likely be both – AI can’t blindly solve all business problems, but those that are able to successfully implement it will see significant margin improvement and efficiencies.

As we enter the final stretch of the year, positioning matters more than ever. Dispersion across sectors and styles is increasing, which means broad market exposure may not be enough. Selectivity, i.e. owning the right assets in the right places, is what will drive performance. We continue to favor quality, growth tied to secular themes like AI and infrastructure, and balance from income-generating assets.

The Economy and Markets

Labor Markets Cooling. The US labor market softened notably through 3Q as job creation slowed and unemployment rose to 4.3%, its highest level since 2021. Wage growth also decelerated, suggesting weaker momentum heading into year-end. While consumers remain resilient, this cooling trend increases the risk of an uneven landing as policy shifts take.

Fed Starts a New Cutting Cycle. The Federal Reserve’s September rate cut, the first since late 2024, marked the official start of a new easing cycle. Policymakers positioned the move as a “risk management” cut, signaling support for growth while acknowledging inflation remains above target. Markets welcomed the decision, though expectations for additional cuts remain data-dependent.

Inflation Moderates Unevenly. Headline inflation eased modestly but remained sticky in services and shelter components. Energy prices stabilized, while core goods prices benefited from improving supply chains. The Fed’s balancing act, cutting rates without reigniting inflation, will be key to maintaining market confidence in Q4.
Government Gridlock Returns. Fiscal tensions flared again in late September as the threat of a government shutdown resurfaced, and then happened at the beginning on 4Q. Rising debt levels and persistent deficits continue to pressure long-term fiscal stability. Investors should remain mindful of policy-driven volatility, particularly in rates and credit markets where yields tend to reflect investor sentiment more than Fed policy.

TIMELY TOPICS

Positioning Into Year-End: Where to Put Capital Now

As we approach the final quarter of 2025 investors face a market with tailwinds from Fed easing but crosscurrents from labor softness, fiscal risk, and expensive valuations. The rally remains intact, but leadership is increasingly narrow and volatility is likely to rise.

For investors we see opportunity in a barbell approach of growth and income. Specifically:

On one side, maintain exposure to secular growth drivers: AI, infrastructure, and high-quality large-cap tech. These remain central to productivity gains and earnings momentum.
On the other, balance portfolios with income-generating, more defensive exposures. Dividend growers, listed infrastructure, and municipals stand out as stable ballast in a shifting environment.

Looking further out the road ahead may not be smooth, but there are alternate routes for investors willing to be selective and disciplined. Year-end positioning should lean into resilience, not chase exuberance.

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