Strategy & Outlook – Third Quarter 2025

Scanning the Horizon: Reading Signals Amid Shifting Themes
Markets entered the final quarter of the year with a current of mixed signals. On the surface, equities pushed toward record highs, supported by persistent enthusiasm around artificial intelligence and a widely expected September rate cut from the Federal Reserve. But beneath the strength, critical questions are emerging around liquidity, valuation, and the durability of consumer demand.

The Fed’s shift toward easing is less about recession fears and more about market function. Tight liquidity and mounting fiscal pressures are pushing policymakers to reassess the viability of ongoing balance sheet reduction. At the same time, stretched valuations, rising delinquencies, and softening economic data are colliding with investor behavior still driven by momentum and fear of missing out. The result is a market that looks strong on the surface but increasingly reliant on supportive flows rather than improving fundamentals.

Key Themes and Considerations
The media spotlight remains fixed on AI, which has driven much of the year-to-date stock market returns. This has pushed valuations to tight levels relative to history. While valuations matter over the long run, investor behavior and sentiment can dominate short-term price action.

The Fed’s policy pivot is coming into focus. While markets continue to speculate about rate cuts, recent commentary points to a deeper concern: market liquidity. Inflation and employment have taken a back seat, not because the Fed is being especially clever or cautious, but because liquidity stress leaves it with no choice. In a credit-driven economy where debt must continually roll over, maintaining liquidity isn’t a strategy, it’s a necessity to prevent systemic breakdown. Ironically, the surge in credit now straining the system is the result of the Fed’s own policies.

While this shift may offer support to risk assets, it also risks reigniting inflation. Without a sharp slowdown, rate cuts alone provide limited relief. Long-duration bonds remain vulnerable to higher yields, with compressed risk premiums and fading demand amid rising supply. We expect some form of QE to return— its timing and scale uncertain, but potentially significant, as the Fed moves to avoid liquidity-driven dislocations in the debt markets.

Meanwhile, economic data continues to soften. Housing affordability remains stretched, delinquencies on auto loans and credit cards are rising, job prospects for recent graduates are weak, inflation is sticky, consumer confidence is slipping, and retail sales are losing momentum. Yet markets keep grinding higher, fueled largely by retail investors caught in a cycle of behavioral bias and fear of missing out. This is evident in household stock ownership, which now sits at a record high¹.

Strategy and Outlook
Sentiment continues to steer market momentum in the near term, underscoring why we are focused on recalibrating risk rather than chasing returns. We are deliberately underweight in concentrated large cap technology where passive flows have distorted valuations beyond fundamental reality and instead have shifted allocations toward a more diversified sector mix that better balances opportunity with discipline.

Parts of the credit market, particularly loan related assets, have undergone meaningful repricing since the third quarter, creating pockets of value across various sub-sectors. We have actively navigated this volatility to identify attractive investment opportunities, yet we remain wary of leveraged credit, where spreads are not offering us enough compensation for potential turbulence.

Liquidity is flowing back, but it is landing in a market where valuations and technicals fail to fully price in uncertainty. This may prolong rallies in the short term, but it also increases the market’s fragility if fundamentals deteriorate. In this environment, flexibility and tactical asset allocation can help investors respond swiftly to changing market conditions.