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During the third quarter, U.S. equity markets continued to deliver strong performance, propelled by solid second-quarter momentum and further fueled by strong corporate earnings, an interest rate cut, and a gradual easing of trade tensions. Equity market breadth also improved during the quarter, with stocks gaining across the board, even as technology and artificial intelligence (AI) stocks remained the primary drivers of growth.
A Softening Employment Picture Reveals an Economy in Transition
The U.S. economy continued to hold up during the quarter, amid ongoing tariff-related noise and a gradual softening in the labor market. The economy was bolstered by positive business sentiment and continued strength in consumer spending, particularly as inflation remained under control thanks to companies’ willingness to absorb tariff-related price increases. As the quarter progressed, however, cracks began to appear in the labor market. Job growth slowed in July and August, and unsettling negative revisions to May and June data revealed an employment picture that was less robust than analysts and investors had realized. By quarter end, unemployment was up to 4.3%, its highest reading since 2021, although it remains well-controlled by historical standards.1
Source: MarketDesk
Fed Cuts Interest Rates and Signals More to Come
As promised, the Federal Reserve (Fed) has been steadfast in letting economic data guide its decisions. It held interest rates steady in July, citing the strong labor market and inflation that lingered above its target 2% rate.2 As evidence of labor market softening appeared in early August, however, the Fed signaled willingness to begin easing. At its annual Jackson Hole conference in August, Fed Chair Jerome Powell indicated that a rate cut was likely. The Federal Open Market Committee followed through at its September meeting, cutting interest rates by a quarter point, the first reduction since December 2024.
At that time, analysts predicted two additional cuts by year-end, and the potential for more in 2026, with interest rates likely to settle at 3.73% by the end of 2025.2 Since then, however, stronger home sales, GDP growth, and consumer spending data have tempered expectations.
Source: MarketDesk
The AI Boom Continues
The artificial intelligence (AI) boom continues to drive equity market leadership and economic growth. Investments in AI infrastructure, including semiconductors, data storage, and power, grew 14% year-over-year during the second quarter, the fastest pace since the late 1990s. While concerns exist about the sustainability of this growth, AI remains an engine for equity markets and the economy, a scenario that appears likely to continue for the foreseeable future.
Stocks Deliver Gains Across the Board
Equity markets have delivered strong returns year-to-date. The S&P 500 Index rose 8% in the third quarter and 14% year-to-date, as of quarter-end.3 Tech stocks have continued to perform well, with the Nasdaq Composite gaining more than 11% for the quarter and 14% year-to-date, as of quarter-end.3
While the tech sector continues to show strength, market leadership has broadened. Notably, small-cap stocks, represented by the Russell 2000, outperformed technology in the third quarter, gaining 12.4% and pushing the index past its 2021 high.3 Additionally, cyclical stocks outperformed defensive ones, signaling positive investor sentiment.
After outperforming U.S. stocks during the first half of the year, international stocks delivered mixed performance in the third quarter. European stocks were flat, but emerging markets outperformed thanks to stimulus measures in China and strong performance from Asian AI companies. Both emerging market and European stocks are up more than 25% year-to-date, beating U.S. stocks by more than 10%.3
Source: MarketDesk
Bond Market: Attractive Yields, But Selectivity Matters
After rising through mid-summer, Treasury yields reversed course later in the quarter as softer employment data and the Federal Reserve’s rate cut reignited demand for fixed income. The 10-year yield retreated toward 4.1%, helping long-duration bonds outperform shorter maturities.3 Corporate credit remained resilient, with investment-grade securities leading high yield and spreads compressing to their tightest levels in years.
At first glance, these tight spreads make bonds appear fully priced. Yet for investors with a disciplined approach, the market still offers constructive opportunities. Yields remain meaningfully higher than the decade preceding the Fed’s hiking cycle, providing a rare chance to secure durable income even if price appreciation slows.
That said, the margin for error is thin. With spreads near historic lows, investors are not being paid much for assuming additional credit or duration risk. This argues for a more selective stance—favoring higher-quality issuers, diversified exposure, and liquidity over incremental yield. Active management can play an important role in this environment: focusing on issuers with improving balance sheets, shorter-dated maturities that can be reinvested at attractive levels, and sectors where fundamentals, not just sentiment, are driving performance.
Source: MarketDesk
The Direction of the U.S. Economy
The U.S. economy has its share of risks heading into the fourth quarter, particularly in the potential for a sharper slowdown in the jobs market or a decline in consumer spending. Still, the current base case is for a soft landing in which growth moderates without a recession. This view is dependent on Fed policy: Gradual rate cuts are expected, but at a pace that is data-dependent.
Meanwhile, investors will contend with equity market risk. Corporate earnings have held up well, but may show signs of strain as tariffs continue to pressure profit margins and supply chains. Further, while AI investment remains a durable, multi-year theme, both valuations and expectations may be optimistic given the strong performance to date.
As always, we encourage investors to stay focused on long-term goals and ensure their portfolios are well diversified. The outperformance of international markets this year offers a case study for the value of portfolio diversification. While analysts can hypothesize about future performance, the reality is that markets can and do move in unexpected directions. Investing broadly, in alignment with your goals and risk tolerance, can help ensure you capture market performance while mitigating risk.
1 Department of Labor
2 Federal Reserve
3 Morningstar
Cary Street Partners is the trade name used by Cary Street Partners LLC, Member FINRA/SIPC; Cary Street Partners Investment Advisory LLC and Cary Street Partners Asset Management LLC, registered investment advisers. Registration does not imply a certain level of skill or training.
Any opinions expressed here are those of the authors, and such statements or opinions do not necessarily represent the opinions of Cary Street Partners. These are statements of judgment as of a certain date and are subject to future change without notice. Future predictions are subject to certain risks and uncertainties, which could cause actual results to differ from those currently anticipated or projected.
We undertake no duty or obligation to publicly update or revise the information contained in this letter. In addition, information related to past performance, while helpful as an evaluative tool, is not necessarily indicative of future results, the achievement of which cannot be assured. You should not view the past performance of securities, or information about the market, as indicative of future results.
Cary Street Partners is a broker-dealer and registered investment adviser and does not provide tax or legal advice; no one should act upon any tax or legal information herein without consulting a tax professional or an attorney.
International and foreign securities are subject to additional risks such as currency fluctuations, political instability, differing financial standards, and the potential for illiquid markets.
Fixed income investments have several other asset-class specific risks. Inflation risk reduces the real value of such investments, as purchasing power declines on nominal dollars that are received as principal and interest. Interest rate risk comes from a rise in interest rates that causes a fixed income security to decline in price in order to make the market price-based yield competitive with the prevailing interest rate climate. Fixed income securities are also at risk of issuer default or the markets’ perception that default risk has increased.
The “Magnificent Seven” refers to a group of seven high-performing, influential stocks in the technology sector. Alphabet (GOOGL; GOOG), Amazon (AMZN), Apple (AAPL), Meta Platforms (META), Microsoft (MSFT), NVIDIA (NVDA), and Broadcom (AVGO).
Comparative Index Descriptions: Historical performance results for investment indices have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings do or will correspond directly to any comparative indices. An investor cannot invest directly in the indices shown, and accurate mirroring of the indices is not possible.
The Standard & Poor’s (S&P) 500 Index is an index of 500 stocks seen as a leading indicator of U.S. equities and a reflection of the performance of the large cap universe, made up of companies selected by economists. The S&P 500 is a market value weighted index and one of the common benchmarks for the U.S. stock market.
The Russell 2000® Index is a capitalization-weighted index designed to measure the performance of a market consisting of the 2,000 smallest publicly traded U.S. companies (in terms of market capitalization) that are included in the Russell 3000® Index.
The MSCI EAFE Index is a stock market index that measures the performance of large- and mid-cap companies across 21 developed markets countries around the world. Canada and the USA are not included. EAFE is an acronym that stands for Europe, Australasia, and the Far East.
The MSCI Emerging Markets is a global stock market index that tracks the performance of large and mid-cap companies across 24 emerging markets. It is maintained by MSCI, formerly Morgan Stanley Capital International, and is used as a common benchmark for global emerging market stock funds.
The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. CSP2025263
