Q3 2025

At the same time, the narrowness of leadership in many markets, especially the US, has presented problems for stock pickers: this phase of the rally has again been astonishingly concentrated, driven by a handful of huge technology firms. The top 20 contributors to Q3 gains in the global index account for more than half of total returns - 17 of these 20 are tech stocks, mostly American, but with an important contribution from Asian tech too, with investors seemingly undeterred by tariffs. This reveals a market driven less by broad-based growth expectations than by continued faith in technology dominance, and the rise of artificial intelligence.

For active stock pickers put off by the extreme valuations of these tech stocks, and looking beyond the unusual concentration at the top of the index (the Top 10 now account for 40% of the index), life has been harder: opportunities existed, but were sometimes hard to find. Diversification into Europe and the UK, into Value stocks and into bonds worked well in the first half of 2025, but these assets have lagged the latest surge in big tech in Q3.

This presents a paradox: active managers avoiding risky over-exposure to expensive and popular stocks that dominate the market have suffered underperformance; passive investors holding the index have benefited from the narrow drivers of strong performance, but may feel vulnerable - what if faith in tech and AI is shaken? What if gravity pulls on those highly-valued stocks?

After Trump’s “Liberation Day” tariffs announced in April, economists had feared a toxic mixture of inflation (as tariffs pushed up import prices) and slower growth (as those higher prices ate into household income). A series of deals and rollbacks limited the scale of tariffs, and the impact has been much less severe than feared: tariffs are now feeding into inflation, now back up to 2.9% in the US, and this could rise further, but the Fed appears inclined to look through the bump as temporary. Business confidence appears to have recovered meaningfully from the early summer dip, indicating that the global economy continues to grow modestly: output and orders continue to rise, although not at a strong enough level to generate strong job growth. Recent data suggests the labour market in the US may be slowing, giving a green light for the Federal Reserve to resume interest rate cuts.

Central banks have trodden a divergent path in 2025, and policy looks set to remain desynchronised into 2026. While the Fed remained on hold until a recent cut to 4.25% in September, the Bank of England and especially the ECB cut steadily through the year and now appear to be near the end of policy loosening. The ECB has cut its main deposit rate from 3% to 2% this year, and markets believe that this cycle is over; the Bank of England has cut from 4.75% to 4%, with perhaps just one more cut expected. By contrast, the Fed is expected to continue easing, judging that downside risks to employment have risen. Markets expect another 4 rate cuts over the next year - but it will be hard for the Fed to maintain that stance if the delayed impact of tariffs continues to force inflation higher.

Overall, the global economy has continued to offer pleasant surprises through this cycle, proving pessimists wrong for now: soft patches have surfaced from time to time, but the economy has continued to expand modestly, navigating potential potholes. In combination with a gradual global loosening of monetary policy, this has been a helpful backdrop for risk assets.

The early summer had seen a sharp stock market recovery from the tariff-related tantrum; the late summer saw momentum maintained, with scarcely a backward step. Global stocks gained over 7% in Q3 and are now up 18% year-to-date (in USD terms). Investors tracking returns in Pounds or Euros see returns in more measured terms, given the Dollar’s 10% decline this year. Fed cuts tend to be supportive for emerging markets - Asian stocks led in Q3 (+10%), driven by tech firms in China, Taiwan and Korea, and Japan surged (+12%): a welcome return to form, after underperformance over the last 5 years.

After strong returns earlier in the year, UK (+6%) and European stocks (+3%) had a quieter Q3, but still comfortably outperformed US equities this year, factoring in currency moves. US equities gained +8% in Q3, again led by large-cap growth (+11%) while value lagged; US small- and mid-cap stocks also rose to record highs, likewise gaining 11%.

Q3 has been largely plain sailing, with no meaningful volatility. Investor optimism has crept higher, suggesting some complacency; this can be a prelude to a correction. But other asset classes reveal ongoing concerns, particularly over public sector fiscal sustainability.

Gold has surged almost 50% this year, up 17% in Q3 to record highs above $3800/oz, marking its best year since the 1970s. Gold mining stocks have responded in highly-geared fashion, doubling year to date, with a near 50% rise in Q3 alone. Surging gold prices are rarely a sign that all is well: investors forgoing yield from bonds or cash to speculate in a metal with no inherent income tells us that concerns are bubbling under the surface - over political unpredictability, over currencies debased by inflation, over fiscal sustainability, and perhaps over geopolitical tensions, despite apparent progress both in the Middle East peace process and a renewed commitment by Trump to NATO.

Fiscal sustainability concerns have been reflected in bond markets too, particularly in UK long-dated bonds, where 30-year gilt yields topped 5.6% in September, the highest levels since 1998. Gilts as a whole gave negative returns in Q3 (inflation-linked gilts lagged further, -8% over the last 12 months), showing market unease about how public sector spending plans can be funded. But let’s not overstate these concerns: the Pound has held steady vs the Dollar after gains earlier in the year and 10-year Gilt yields have held in a narrow range since December. Alarm bells are not ringing.

US bonds fared better, with modest gains across the curve, as yields were anchored by expectations of Fed rate cuts. This also suggests that concerns about inflation have not become too elevated: if markets come to fear that Fed rate cuts will pour fuel onto an inflationary fire, we would expect to see long-dated Treasury yields rising while the short-end remains pinned lower - if that were to happen, it could be a much more challenging environment for both markets and the real economy.

Once again, riskier bonds generated positive returns, including emerging market bonds and high yield bonds issued by less creditworthy companies. Over the last twelve months, returns of 6-8% from these sectors of the bond market fall short of surging equity markets but have been useful contributors to diversified, cautious, or balanced portfolios.

We suggested last quarter that bond yields approaching 5% were not a crisis, but part of a return to normality. After years of “financial repression” keeping bond yields artificially low, the last three years have seen a transition towards more accustomed ranges. Benchmark US and UK bond yields remain within manageable territory for stocks and for the real economy. For investors building well-diversified portfolios, high quality bonds yielding 4-5% merit consideration; but, a note of caution: investors tempted to reach down the creditworthiness scale are receiving ever-slimmer compensation for the risks they run. That may not be an issue while the Fed’s generosity on interest rate cuts is lifting all boats, but today’s high yield bonds yielding around 6% offer little extra reward for lending to lower quality companies, who would be most vulnerable to bankruptcy when the tide eventually goes out.

Global monetary policy is becoming more fragmented: expectations of continued Fed interest rate cuts are anchoring short-dated bonds in the US and may support (for now!) riskier bonds and emerging markets, while also dimming the Dollar’s appeal. Meanwhile, UK and European central banks are close to calling a halt to rate cuts. This complicates the environment but suggests a landscape rich in opportunity for active and dynamic bond portfolios.

Markets have been resilient, but complacency can set-up the next setback, especially when forward momentum rests on a narrow and expensively valued foundation of technology stocks. The Fed is acting to support economic growth, but inflation remains a concern, and trade policy disruptions may yet impact prices and hurt consumers. While growth continues and faith in the AI-future is maintained, stocks can rise further, and valuations expand. It’s impossible to say when the mood will change, but diversification into less richly valued and less popular assets will give protection when it does.

N.b. All content is based on data at the time of writing on 07/10/25.