Investment Management - Third Quarter 2025

The Season of Change

With leaves turning and temperatures falling, the transition to autumn is an apt metaphor for the current investment landscape, where market expectations are similarly in flux. Shifting government policies have created considerable uncertainty, while economic indicators paint an increasingly colored portrait of growth, inflation, and employment trends. Much like preparing for the cooler weather ahead, investors should be reassessing their strategies, ensuring asset allocations remain aligned with long-term objectives and the changing conditions before them. In this environment of transition – both meteorological and economic – flexibility becomes paramount.

Key Takeaways from the Third Quarter

• Equity markets finished at or near all-time highs, with the S&P 500 rising 8.12% as AI momentum and Federal Reserve rate cut expectations drove gains across market capitalizations.
• The Fed began its easing cycle with a 25-basis point cut in September, signaling additional reductions ahead while balancing persistent inflation against a softening labor market.
• Economic resilience surprised skeptics, as gross domestic product (GDP) grew 3.8% in the second quarter and is expected to continue this trend in the third quarter, with consumer spending remaining robust despite earlier concerns about employment, inflation, and debt levels.
• Policies and actions at a hurricane’s pace with the passage in July of the One Big Beautiful Bill Act, tariff implementation in August, and the government shutdown at the end of September.

The Harvest: Market Performance
Despite uncertainty around foreign trade and monetary policy, a softening labor market, and stretched valuations, equity markets continued their ascent in the third quarter, driven largely by momentum in the artificial intelligence (AI) sector and anticipation of interest rate cuts by the Federal Reserve. The S&P 500 index rose 8.12% during the quarter, finishing just below the all-time high set on September 22. Gains were not confined to the largest companies, as the S&P 400 Mid Cap index advanced 5.55% and the S&P 600 Small Cap index lead the way with a 9.11% advance. International equities, as tracked by the MSCI EAFE index, rose 4.77%, trailing domestic indices for the quarter but still outperforming on a year-to-date basis.

 Performanceⁱ for various indices for the three-month (not annualized), one-year, three-year, and five-year periods appears below:

Bond Indices

Equity Indices

Falling Leaves: Government Policy Shifts

Tariff policies implemented throughout the year have created both challenges and opportunities across sectors and regions. This uncertainty continues to create selective headwinds, impacting companies with significant international supply chain operations. Manufacturing and consumer goods companies remain sensitive to tariff announcements, while domestic-focused businesses should benefit from reduced competitive pressure. Tariff-related volatility and administration dealmaking will likely persist as themes in the fourth quarter, requiring careful sector allocation and company-specific analysis to navigate these challenges effectively. 

While garnering a considerable amount of press, government shutdowns have historically had minimal lasting impact on equity markets, typically resulting in short-term volatility that quickly dissipates once a resolution is found. Markets generally view these events as temporary political theater rather than fundamental economic threats, with the S&P 500 returning 12.7%, on average, in the twelve months following a shutdown.ⁱⁱ

Weather Forecast: Economic Indicators and Labor Market Conditions
 Economic indicators released throughout the quarter have largely contradicted public perception of U.S. economic health. As tariff effects have taken longer to filter through to price increases, consumer spending has stabilized. This was evident in the final reading of second quarter GDP at 3.8%, much stronger than initially reported. Consumer spending, the primary driver of economic activity accounting for over two-thirds of GDP, drove much of the upward revision, mainly due to services spending rather than on goods. Growth is expected to remain steady, as evidenced by the Atlanta Fed’s GDPNow forecast of 3.9% growth for the third quarter.ⁱⁱⁱ

Over the past few years, many have cautioned consumer spending would slow due to employment concerns, inflation, and expanding consumer debt. However, consumer spending has increased over these years, and the savings rate has grown along with GDP,^iv outshining almost every other major developed economy. Baby Boomers, who hold approximately $85 trillion or 51% of total household net worth,^v will continue spending throughout retirement, likely pushing the savings rate lower. 

Large negative revisions to non-farm payrolls suggest the labor market may not be as strong as previously thought. While initial jobless claims remain steady, continuing claims have been persistently higher. Companies are not laying off workers in large numbers but are hiring at reduced rates. Job seekers face greater difficulty finding positions, and the unemployment rate has crept to 4.3%. 

First Frost: Federal Reserve Policy

Perhaps the most significant development during the quarter came from the Federal Reserve’s meeting in September. As was widely expected, policymakers reduced the federal funds rate for the first time this year by 25 basis points to a target range of 4.00%-4.25%. The Fed also provided an updated summary of economic projections and dot plot, showing a median expectation for rates to decline to 3.5%-3.75% by the end of 2025, suggesting two additional quarter-point reductions.^vi While there is some debate as to whether these reductions are warranted given overall economic strength, the Fed has concluded that a slowing labor market takes precedence over persistent inflation. We do not believe the Fed will enter an aggressive rate-cutting cycle with inflation still well above their 2% target, and trending higher, assuming they remain independent. 

Although the Fed cut rates and signaled more cuts ahead, not all rates are declining. Short-term rates have fallen in reaction to monetary policy, while longer-term rates are not declining as quickly. Investors are demanding higher premiums for longer-term debt due to inflation expectations, higher government deficits, and stronger GDP growth. The 10-year Treasury yield closed the third quarter at 4.15%, relatively unchanged from the second quarter, but still higher than the level seen when the Fed began cutting rates in September 2024.

Extended Growing Season: Corporate Earnings & AI Momentum

According to FactSet, second quarter sales grew 6.4% while earnings per share grew 12% as profit margins expanded.^vii  Over 80% of companies delivered positive profit surprises, while stocks missing expectations sold off more heavily than average.^viii This trend is expected to continue when third quarter results are released in the coming weeks, with ten of the eleven S&P sectors expected to grow revenues year-over-year and seven expected to grow earnings.^ix If this comes to fruition, it will mark the ninth straight quarter of earnings growth.

Technology continued in its leadership position, with AI and automation themes remaining prominent. Companies are investing heavily in productivity-enhancing technologies that may prove crucial in a higher-cost environment, particularly as it relates to hiring decisions. According to JPMorgan Asset Management, since the ChatGPT moment in November 2022, AI-related stocks have delivered 75% of the S&P 500 index’s return, 80% of the earnings growth, and 90% of the capital spending growth.^x Previously capital-light businesses have turned into massive investors as cash flows are being fully utilized and reinvested into the business. Nearly three years from this revolutionary moment, and so far, the investment appears to be working. Growth is strong, margins and productivity are up, as are returns on investment.

Since the start of the bull market on October 12, 2022, the S&P 500 index has risen over 95%. While not the longest or strongest bull market on record, it does call into question near-term upside potential. Valuations appear stretched, with the S&P 500 trading at 22.9x forward earnings at quarter-end. Even Fed Chairman Jerome Powell has taken notice, commenting, “by many measures, equity prices are fairly highly valued” during a speech shortly following the September Fed meeting.^xi This reminds us of former Fed Chairman Alan Greenspan’s “irrational exuberance” comment in December 1996, when the market was trading at 21x.^xii It is instructive to note that markets continued to advance for another three years and reached a peak valuation of just over 30x in March 2000 when the tech bubble burst. While there are no guarantees that history will repeat itself, we do believe there is room for continued expansion given innovation, increased business quality, and the strength of corporate balance sheets relative to the late 1990s.  

Preparing for Winter: Portfolio Positioning

As markets reach new highs, we continue rebalancing portfolios to take advantage of attractive buying opportunities while still looking to keep equity allocations within 3-5% of their stated target. While maintaining a bias towards domestic equities, we are selectively increasing allocations to international markets, where appropriate. 

As mentioned in our last quarterly letter, we continue to shift taxable accounts away from actively managed mutual funds in favor of more tax-efficient exchange-traded funds (ETFs). As we approach year end, we track estimated capital gain distributions from funds, in addition to gains and/or losses from our activity, to get a better sense of tax implications. Please reach out to your team if you would like an estimate for tax planning purposes.

Our fixed income positioning reflected expectations for a more accommodative monetary policy environment. As short-term rates decline, we have utilized excess cash, where possible, to lock in attractive yields.

Looking Forward

Several key themes will likely drive fourth quarter performance. The Federal Reserve’s policy path remains crucial, with markets closely monitoring economic data for signals about future rate adjustments. Corporate earnings reports will provide insight into how companies are managing cost pressures and adapting to changing trade conditions.

Geopolitical developments require continued monitoring, as they have potential to influence both market sentiment and actual economic conditions. The global economy’s adjustment to new trade patterns will likely create volatility but also opportunities for well-positioned investments.

Firm News & Compliance Reminders

We are happy to announce the following promotions in September. Senayda Trejo, our former administrative assistant/receptionist has been promoted to the client services department as a client service associate. Also, Jack Lawrence joins the financial planning team as an associate financial planner, from his prior role as senior client service associate/securities trader. Congratulations to you both! 

Also in September, Kristan Anderson, Victoria Henry, Brian Horan, and Kirstie Martinez were named to Northern Virginia Magazine’s Top Financial Professionals^xiii listing.

Please contact us with questions regarding year-end tax planning and gifting needs. You should receive account statements from the custodian where your assets are held at least quarterly. If you are not receiving statements from your custodian(s), please contact us at your earliest opportunity. Additionally, we have included our annual Privacy Notice, stating our policy on the confidentiality of client information. The material change that has been made to the Privacy Notice is the change of ownership from Sandy Spring Bank, a division of Atlantic Union Bank, to Atlantic Union Bank on October 13, 2025. Our current Privacy Notice is also available on our website (https://westfinancial.com/disclosures).

Follow us on LinkedIn or or go to www.westfinancial.com to view our recent blog posts. Thank you for your continued confidence in West Financial, and please do not hesitate to refer friends, family, or co-workers who you feel may benefit from our service.

Brian L. Mackin, CFP^®

President

^I _{Each of the S&P 500 Index, the S&P 400 Index, the S&P 600 Index, the MSCI EAFE Index, the ICE BofA 1-5 Year Index, the ICE BofA 1-10 Year Index, the ICE BofA 1-12 Year Municipal Bond Index, the Dow Jones Industrial Average, and the NASDAQ Composite (each, an “Index”) is an unmanaged index of securities that is used as a general measure of market performance. The performance of an Index is not reflective of the performance of any specific investment. Each Index comparison is provided for informational purposes only and should not be used as the basis for making an investment decision. Further, the performance of your account and each Index may not be comparable. There may be significant differences between the characteristics of your account and each Index, including, but not limited to, risk profile, liquidity, volatility and asset comparison. The performance shown for each Index reflects no adjustment for client additions or withdrawals, and no deduction for fees or expenses. Accordingly, comparisons against the Index may be of limited use. Investments cannot be made directly into an Index.}

ⁱⁱ _{https://www.carsongroup.com/insights/blog/lets-talk-about-a-government-shutdown/}

ⁱⁱⁱ _{https://www.atlantafed.org/cqer/research/gdpnow}

^iv _{https://fred.stlouisfed.org/series/PSAVERT}

^v _{Yardeni Research – September 28, 2025}

^vi _{https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20250917.pdf}

^vii _{FactSet Research Systems. (n.d.). Earnings Insight. Butters, John (October 3, 2025). Retrieved October 3, 2025, from https://www.factset.com/}

^viii _{FactSet Research Systems. (n.d.). Earnings Insight. Butters, John (October 3, 2025). Retrieved October 3, 2025, from https://www.factset.com/}

^ix _{Yardeni Research – 9/30/25.}

^x _{https://assets.jpmprivatebank.com/content/dam/jpm-pb-aem/global/en/documents/eotm/the-blob.pdf}

^xi _{https://www.cnbc.com/2025/09/25/federal-reserve-chair-jerome-powell-warns-stocks-are-fairly-highly-valued.html}

^xii _{https://finance.yahoo.com/news/back-90s-fed-chief-warned-100000785.html}

^xiii _{To compile the Top Financial Professionals list, Northern Virginia Magazine sent surveys to Northern Virginia financial professionals asking them to recommend other financial professionals whom they would refer to friends and family. The Northern Virginia Magazine editorial staff then vetted those nominated to compile the final list. Financial professionals do not pay a fee to be included on the list. Although some Top Financial Professionals winners choose to advertise in the magazine. The Top Financial Professional listing and the advertising section are separate entities.}

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_{Certain information contained herein was derived from third party sources as indicated. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. WFS has not and will not independently verify this information. Where such sources include opinions and projections, such opinions and projections should be ascribed only to the applicable third party source and not to WFS.} 

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