The third quarter of 2025 saw positive returns across most major asset classes as trade tensions subsided.
Investor optimism around Artificial Intelligence (AI) continued to dominate sentiment, underpinning returns in both developed and emerging markets. The Federal Reserve’s first interest rate cut in over a year added further momentum, though concerns persist about the durability of US labour market strength and the implications of elevated corporate valuations.
Economic Review and Outlook
The global economy continues to show signs of slowing momentum. Growth is now projected at around 2.5% for 2025 – the weakest since the pandemic
downturn – with developed markets decelerating to 1.5% and emerging economies at 4%. In the United States, data paints a mixed picture. Retail sales have remained robust, largely driven by wealthier households, yet labour market indicators have weakened noticeably. August non-farm payrolls added just 22,000 jobs, far below expectations, and manufacturing employment has contracted for four consecutive months. While GDP growth in Q3 is estimated at 2.0–2.5%, the underlying pace of expansion appears to be moderating, raising the risk of recession by 2026–27.
Inflation trends are encouraging but remain above target. In August, the US Consumer Price Index (CPI) registered 2.9% year on year, with core at 3.1%. The Federal Reserve (Fed) responded by
lowering interest rates to 4% and signalling further cuts in Q4, with markets pricing rates closer to 3% by mid-2026. Political pressure from the White House for more aggressive easing complicates the policy backdrop
and has unsettled some bond investors. The UK economy, surprisingly, has outpaced peers with 1.1% growth in the first half of 2025, supported by services sector expansion. Yet sentiment remains fragile, given concerns about business costs, gilt market volatility, and uncertainty surrounding the November budget.
Europe remains subdued, with GDP growth hovering near zero this year but is expected to strengthen in 2026 as fiscal programmes begin to take effect. The imposition of US tariffs – a 15% blanket rate alongside higher sector-specific measures – is weighing on export-oriented industries. Germany is relying on infrastructure investment to offset this weakness.
China is targeting 5% growth this year, but momentum is uneven, with industrial production and retail sales under pressure. Authorities may be compelled to add stimulus to sustain activity. By contrast,
India is exhibiting robust expansion, with record-high Purchasing Managers’ Indexes (PMIs) reflecting strong domestic demand.
Looking forward, the outlook hinges on the interplay between monetary policy, AI-driven capital investment, and the durability of consumer spending. Risks include weaker labour dynamics in the US, geopolitical trade disputes, and the prospect of inflation persistence undermining further rate cuts.
Growth Asset Summary
Equities led the way in Q3, with global stocks up more than 7.5%, while Japanese markets outperformed, rising 13.0%. The US large cap index gained more than 8%, driven by technology mega-caps. The Magnificent 7 continue
to dominate market performance, supported by surging AI investment, which is projected to exceed $385 billion by year-end. Earnings momentum has been concentrated in these names, with 27% annualised Earnings Per Share (EPS) growth in Q2. Broader market participation remains more limited, reflecting underlying economic softness.
UK equities have lagged over the longer term, reflecting weaker corporate profit growth relative to US peers. However, the UK’s relative economic resilience in H1 2025 may present selective opportunities, with UK large caps up
7.2%, while mid-sized companies gained only 2.1%. Europe returns were more modest at 4.65%, constrained by tariffs and weakness in healthcare stocks, which fell sharply following Trump’s announcement of 100% tariffs on branded drugs. Nevertheless, attractive valuations, accommodative monetary policy, and fiscal stimulus plans provide potential medium-term support.
Emerging market equities outperformed 11%, buoyed by a weaker dollar and state support for technology sectors in China. Alibaba, for instance, rallied 55% over the quarter as it unveiled new AI partnerships. Indian equities also benefited from strong domestic growth and capital inflows. Overall, growth assets remain supported by liquidity and AI enthusiasm, but valuations – particularly in the US – demand ongoing earnings growth to be sustainable.
Factor Performance
Factor dynamics in Q3 reflected ongoing bifurcation:
- A Growth vs value: Growth, led by technology, continued to dominate in the US, although value styles performed better in Europe and emerging markets where cyclical sectors outperformed.
- Overall growth delivered 10.23% while value was nearly half that at 5.85%.
- High-quality companies with strong balance sheets and durable cash flows attracted investor interest amid ongoing macroeconomic uncertainty.
- A Momentum remained robust, tied to the AI narrative, but risks of reversal are growing as positioning becomes crowded.
- Larger stocks continue to outperform their smaller peers – a trend that has persisted – although the small-cap style still returned a solid 8.15%.
Looking ahead, style leadership may hinge on whether AI-driven capital expenditure delivers tangible productivity gains across a broader base of companies. If not, concentrated leadership could give way to a rotation into value or defensive stocks.
Defensive Asset Summary
Bond markets reflected diverging regional risks. US Treasuries rallied as yields fell 0.25% in September, with the 30-year yield retreating to 4.7%. The market welcomed rate cuts but remains watchful of fiscal slippage and political interference in Fed independence. UK gilts suffered sharp losses, down around 6% in Q3. Investors are wary of the upcoming budget and rising borrowing requirements. Demand at recent auctions was the weakest in two years.
Core Eurozone bonds remain supported by subdued inflation, though divergence between sectors persists. Notably, French yields spiked on budgetary concerns, even briefly exceeding corporate
borrowing costs. Credit spreads are historically tight, with investment grade at 0.74% and high yield at 2.69%. These levels – roughly half long-run averages – leave little cushion should growth falter.
The defensive landscape remains challenging, with elevated sovereign risks in the UK and Europe, while credit valuations appear stretched. Commodities provide diversification but are themselves tied to geopolitics and monetary credibility.
Closing Remarks
Markets remain buoyed by a powerful combination of easing monetary policy and enthusiasm for AI-driven innovation. This “Goldilocks” narrative – not too hot, not too cold – has carried risk assets to strong gains through 2025. Yet beneath the surface lie important vulnerabilities. Labour market weakness in the US, ongoing trade frictions, and political interventions in central banking, all carry the potential to destabilise sentiment. Valuations across US equities and credit markets are historically rich, leaving little margin of safety. Meanwhile, Europe and the UK face fiscal questions, and China continues to grapple with structural headwinds.
We continue to advocate for a diversified, strategically balanced approach. While equities remain the “easy” choice in a liquidity-driven environment, the harder question is how to capture the AI theme without overexposure to crowded trades. Selective exposure to value opportunities outside the US, balanced with high-quality growth leaders, appears prudent. On the defensive side, maintaining flexibility in duration and credit exposure, while incorporating diversifying assets such as commodities, will be key.
Ultimately, we expect further volatility as markets reconcile the optimism of innovation and policy easing with the reality of slowing global growth. A disciplined, long-term approach focused on diversification remains the most effective way to navigate this environment.
Important Note
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This article is distributed for educational purposes only. This communication does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs.
The opinions stated in this document are those of the author and do not necessarily represent the view of Progeny and should not be relied upon to make a financial decision.
Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is no guarantee of future performance.
The value of an investment and the income from it can fall as well as rise and investors may get back less than they invested. Your capital is therefore always at risk. It should be noted that stock market investing is intended for the longer term.
