Executive Summary:
- Financial Markets Post Strong Third Quarter on Fed Ease and Technology Strength
- Fed’s Powell Executes Policy Shift While Keeping Market Disruption in Check
- Economy and Job Market Show Signs of Fatigue
- The AI Game is Big, and the U.S. and China are Playing it Differently
- Portfolio Trades Play Down U.S. Economic Sensitivity, Edge into EM
What happened in the financial markets in the third quarter, and what drove returns?
Both stock and bonds enjoyed a strong third quarter of 2025, adding significantly to half-year gains. After a sell-off early in the year, leadership was restored by the large technology companies. This was driven by easing tariff worries in that sector and an improved earnings picture, better supporting lofty valuations. The S&P 500 rose a hefty 8.1%, bringing its year-to-date gain to 14.7%. The “Fab 7” names, representing about 37% of the index, posted an upper-teens aggregate return in the quarter. Equity strength continued overseas as well, with developed international markets rising 5.6% to bring their year-to-date increase to 27.5% (the latter number helped by the U.S. dollar’s roughly 10% retreat), and emerging markets gaining 10.1% in the quarter and 24.0% for the nine months.
Bond prices were supported by widespread anticipation of a September Federal Reserve rate cut, amidst signs of a cooler job market. The Fed indeed cut its policy rate by a quarter point to the 4.00-4.25% range on the 17th. Bonds now have recovered solidly following their historic retreat in 2022, the AGG index gaining 13.7% since a 13.0% drop in that year.
Tariffs created fewer headlines but still increased in certain countries (e.g. India, Brazil, and Canada) and sectors (e.g. heavy trucks, wood and pharmaceuticals). The collective worldwide tariff rate has edged up to around 19.5%, about a percent higher than earlier in the year and well above the 2.5% rate in 2024. But companies have shown an ability to stay a step or two ahead of Washington, pivoting suppliers and stockpiling materials as needed. Also, contrary to earlier fears, most other countries have not aggressively retaliated, instead strengthening ties to alternate partners, leaving the “trade war” waging mostly to the U.S. on its own.
Can the Fed thread the needle with its mandates in tension?
Jay Powell and the Federal Reserve policy committee, under ever-brightening lights, managed to navigate market currents with relatively little disruption during the quarter. With decelerating job growth – only 598,000 have been added this year through August, the smallest ex-COVID number since 2009, and it ground to a virtual halt over the summer — Powell was able to tee up a cut at Jackson Hole in August and then do so a few weeks later. Investors now expect at least one more cut this year, with another to follow by early 2026.
But visions of greater cuts, preferred by the White House, have been held in check with inflation firmly stuck around the 3% level, still a point away from a 2% target that has repeatedly moved out further on the horizon. This is the “tension” the Fed now is contending with as it pursues its dual mandate of full employment and price stability. With the rate cut, Powell is favoring the jobs half at present. What remains to be seen is the impact of reduced immigration on labor market dynamics, as it looks like lower worker count may be offsetting some of the job growth reduction, keeping the unemployment rate at its historically low 4.3% level.
With memories of market-gutting policy shocks in the 1990s and living through the hyper-vigilance around the 2008 global financial crisis, the Fed has made communication and transparency key priorities — press conferences started following the main four meetings a year in 2011 under Ben Bernanke, and then moved to all eight in 2019 under Powell. Investors have welcomed, and likely benefitted from, the practice.
What is the trendline for the GDP and what will drive growth?
The economic picture has been particularly tricky to read so far in 2025, thanks to major swings in net exports. A big surge in imports to front-run anticipated tariffs occurred in the first quarter, severely hindering net exports and the overall GDP reading, and this was followed by a sharp reversal and the opposite effect in the second quarter. But stripping out the trade component, underlying GDP appears to have slowed to something around 1.4% annualized growth so far in 2025, down from 2.8% in 2024. Today, headwinds appear to be increasing, with the deceleration in job growth and now a government shutdown, of indeterminate length but surely more impactful with each day.
Does this mean zero or negative growth ahead? Not necessarily: the economy has shrugged off dark signals and defied recession in recent years, with just enough consumption, corporate investment, and government spending to provide positive growth. Recently, the corporate contribution has picked up the slack, powered by the AI buildout, and its infrastructure and electricity grid in particular. The large Fab 7 tech firms alone are expected to spend around $300 billion (about 1% of GDP) on AI-related data centers and computing power this year, versus $200 billion in 2024.
Going forward, continued support from AI spending may depend on whether companies see a return on their investment, as there are some signs (provided by Bain & Co., among others) of over-building and a pushing out of the payback timetable. This is very hard to determine, and the rapidly changing nature of the technology itself poses major challenges for any longer-term capital spending planning or program. Still, the U.S. economy is expected to derive major AI benefits, and it firmly occupies a leadership position in the most transformative aspects of the technology.
Does China pose any threat to the US in AI?
Our country is the current AI leader thanks in part to trade restrictions; the U.S. has control of the semiconductor supply chains and the most advanced chips. Indeed, much of its power is concentrated in one company – Nvidia. The U.S. dominates the pursuit of hyper-advanced language learning models and next level generative AI (AGI), which ultimately could replicate virtually any intellectual task a human can do. This will provide a big edge in major pursuits such as curing cancer, reducing pollution and conducting military campaigns.
But the U.S. clearly isn’t alone. China, for one, has operated more under the radar, making important strides. While also seeking AGI capability, it also is playing a shorter game at more basic intellectual levels, seeking to maximize applications available to them today from “open source” models. AI currently supports weather forecasting and smarter farming, and hospital radiology labs are using AI to improve imaging. China has more robots in today’s factories than the rest of the world combined, and five times as many as the United States.
The U.S. is investing heavily in computing power and infrastructure, which should help maintain its competitive edge. But what makes that uncertain is the aforementioned rapidity with which the underlying technology is changing, possibly rendering some of the infrastructure obsolete before it comes on line. The U.S. may also face challenges from its new $100,000 H-1B visa requirement, and some switching at the top ranks of U.S. and Chinese universities in favor of the latter.
Overall, there should be room for both countries to chart courses to thrive. And while the U.S. and China are the clear AI leaders, hundreds of billions are also being invested by the European Union, Japan, South Korea, and Canada, among others.
Are there any changes in portfolio positioning, and if so, why?
The early 2025 technology underweight was helpful as Nvidia and its brethren rechecked lofty valuations and largely retreated. But the relative strength has returned since the Spring –fortunately, exposure was restored in early June. We now are maintaining roughly an equal weight.
Entering this last quarter, we have consciously pulled back on economically sensitive U.S. equities given the possibility of slower GDP growth. Meanwhile we have added a bit to emerging markets and China, as there may be an argument there on both fundamental and valuation grounds.
Overall, portfolio positioning has been designed to capture the market strength while keeping some defense in place. It is of course a balancing act, and we are wary of elevated valuations in the U.S. On this landscape, diversification maintains an essential role. We will stay focused on the medium-to-longer term horizon, recognizing that any sell-off and loss of value is likely to be reclaimed over a reasonable period, and sometimes quickly.
Finally, we have added a private investments vehicle to our platform and view it as an appealing addition and also a diversifier (newly accessing a vibrant roughly $12 trillion market), to be considered as appropriate. More to follow.
Thayer Partners Quarter 3 Investment Commentary
Executive Summary:
What happened in the financial markets in the third quarter, and what drove returns?
Both stock and bonds enjoyed a strong third quarter of 2025, adding significantly to half-year gains. After a sell-off early in the year, leadership was restored by the large technology companies. This was driven by easing tariff worries in that sector and an improved earnings picture, better supporting lofty valuations. The S&P 500 rose a hefty 8.1%, bringing its year-to-date gain to 14.7%. The “Fab 7” names, representing about 37% of the index, posted an upper-teens aggregate return in the quarter. Equity strength continued overseas as well, with developed international markets rising 5.6% to bring their year-to-date increase to 27.5% (the latter number helped by the U.S. dollar’s roughly 10% retreat), and emerging markets gaining 10.1% in the quarter and 24.0% for the nine months.
Bond prices were supported by widespread anticipation of a September Federal Reserve rate cut, amidst signs of a cooler job market. The Fed indeed cut its policy rate by a quarter point to the 4.00-4.25% range on the 17th. Bonds now have recovered solidly following their historic retreat in 2022, the AGG index gaining 13.7% since a 13.0% drop in that year.
Tariffs created fewer headlines but still increased in certain countries (e.g. India, Brazil, and Canada) and sectors (e.g. heavy trucks, wood and pharmaceuticals). The collective worldwide tariff rate has edged up to around 19.5%, about a percent higher than earlier in the year and well above the 2.5% rate in 2024. But companies have shown an ability to stay a step or two ahead of Washington, pivoting suppliers and stockpiling materials as needed. Also, contrary to earlier fears, most other countries have not aggressively retaliated, instead strengthening ties to alternate partners, leaving the “trade war” waging mostly to the U.S. on its own.
Can the Fed thread the needle with its mandates in tension?
Jay Powell and the Federal Reserve policy committee, under ever-brightening lights, managed to navigate market currents with relatively little disruption during the quarter. With decelerating job growth – only 598,000 have been added this year through August, the smallest ex-COVID number since 2009, and it ground to a virtual halt over the summer — Powell was able to tee up a cut at Jackson Hole in August and then do so a few weeks later. Investors now expect at least one more cut this year, with another to follow by early 2026.
But visions of greater cuts, preferred by the White House, have been held in check with inflation firmly stuck around the 3% level, still a point away from a 2% target that has repeatedly moved out further on the horizon. This is the “tension” the Fed now is contending with as it pursues its dual mandate of full employment and price stability. With the rate cut, Powell is favoring the jobs half at present. What remains to be seen is the impact of reduced immigration on labor market dynamics, as it looks like lower worker count may be offsetting some of the job growth reduction, keeping the unemployment rate at its historically low 4.3% level.
With memories of market-gutting policy shocks in the 1990s and living through the hyper-vigilance around the 2008 global financial crisis, the Fed has made communication and transparency key priorities — press conferences started following the main four meetings a year in 2011 under Ben Bernanke, and then moved to all eight in 2019 under Powell. Investors have welcomed, and likely benefitted from, the practice.
What is the trendline for the GDP and what will drive growth?
The economic picture has been particularly tricky to read so far in 2025, thanks to major swings in net exports. A big surge in imports to front-run anticipated tariffs occurred in the first quarter, severely hindering net exports and the overall GDP reading, and this was followed by a sharp reversal and the opposite effect in the second quarter. But stripping out the trade component, underlying GDP appears to have slowed to something around 1.4% annualized growth so far in 2025, down from 2.8% in 2024. Today, headwinds appear to be increasing, with the deceleration in job growth and now a government shutdown, of indeterminate length but surely more impactful with each day.
Does this mean zero or negative growth ahead? Not necessarily: the economy has shrugged off dark signals and defied recession in recent years, with just enough consumption, corporate investment, and government spending to provide positive growth. Recently, the corporate contribution has picked up the slack, powered by the AI buildout, and its infrastructure and electricity grid in particular. The large Fab 7 tech firms alone are expected to spend around $300 billion (about 1% of GDP) on AI-related data centers and computing power this year, versus $200 billion in 2024.
Going forward, continued support from AI spending may depend on whether companies see a return on their investment, as there are some signs (provided by Bain & Co., among others) of over-building and a pushing out of the payback timetable. This is very hard to determine, and the rapidly changing nature of the technology itself poses major challenges for any longer-term capital spending planning or program. Still, the U.S. economy is expected to derive major AI benefits, and it firmly occupies a leadership position in the most transformative aspects of the technology.
Does China pose any threat to the US in AI?
Our country is the current AI leader thanks in part to trade restrictions; the U.S. has control of the semiconductor supply chains and the most advanced chips. Indeed, much of its power is concentrated in one company – Nvidia. The U.S. dominates the pursuit of hyper-advanced language learning models and next level generative AI (AGI), which ultimately could replicate virtually any intellectual task a human can do. This will provide a big edge in major pursuits such as curing cancer, reducing pollution and conducting military campaigns.
But the U.S. clearly isn’t alone. China, for one, has operated more under the radar, making important strides. While also seeking AGI capability, it also is playing a shorter game at more basic intellectual levels, seeking to maximize applications available to them today from “open source” models. AI currently supports weather forecasting and smarter farming, and hospital radiology labs are using AI to improve imaging. China has more robots in today’s factories than the rest of the world combined, and five times as many as the United States.
The U.S. is investing heavily in computing power and infrastructure, which should help maintain its competitive edge. But what makes that uncertain is the aforementioned rapidity with which the underlying technology is changing, possibly rendering some of the infrastructure obsolete before it comes on line. The U.S. may also face challenges from its new $100,000 H-1B visa requirement, and some switching at the top ranks of U.S. and Chinese universities in favor of the latter.
Overall, there should be room for both countries to chart courses to thrive. And while the U.S. and China are the clear AI leaders, hundreds of billions are also being invested by the European Union, Japan, South Korea, and Canada, among others.
Are there any changes in portfolio positioning, and if so, why?
The early 2025 technology underweight was helpful as Nvidia and its brethren rechecked lofty valuations and largely retreated. But the relative strength has returned since the Spring –fortunately, exposure was restored in early June. We now are maintaining roughly an equal weight.
Entering this last quarter, we have consciously pulled back on economically sensitive U.S. equities given the possibility of slower GDP growth. Meanwhile we have added a bit to emerging markets and China, as there may be an argument there on both fundamental and valuation grounds.
Overall, portfolio positioning has been designed to capture the market strength while keeping some defense in place. It is of course a balancing act, and we are wary of elevated valuations in the U.S. On this landscape, diversification maintains an essential role. We will stay focused on the medium-to-longer term horizon, recognizing that any sell-off and loss of value is likely to be reclaimed over a reasonable period, and sometimes quickly.
Finally, we have added a private investments vehicle to our platform and view it as an appealing addition and also a diversifier (newly accessing a vibrant roughly $12 trillion market), to be considered as appropriate. More to follow.