The Brave Report: Market Commentary for Q3 2025

Bubble or bull run?  With the markets continuing to hit all-time highs, valuations continue to be called into question. Mega-cap technology names have been the big drivers behind market performance and now make up a disproportionate percentage of the overall market cap.   Concerns over a market bubble, driven by the frenzy around AI, have increased the probability of volatility as we head into year-end.  However, even with these concerns, earnings performance has been robust. The Fed has started cutting rates, and concerns around tariffs have been muted.  The big question we are dealing with moving forward is, are companies going to be able to translate their large AI spend into company performance and growth?

Market Overview

Markets again vaulted forward in the third quarter, driven by large technology names.  The S&P 500 and the Dow grew by around 8% and 5% respectively, while the NASDAQ grew by 11.2%.  This brings year-to-date gains to almost 15% for the S&P 500 and almost 35% from the April lows.  We have also started to see increased performance from the international markets and small caps.  Developed non-US markets are now up 25% for the year, and emerging markets have risen 28%.

Bonds continued to rally amid rate cut expectations and cooling inflation.  The Fed cut rates by 25 basis points in September and signaled additional rate cuts ahead.  The yield on the 10-year dropped to near 4% during the quarter after hitting 4.8% in January.  The lower rate environment should continue to stimulate the economy, but worries around the fiscal deficit will put an opposing upward force on rates and may prevent the rate cuts from having the full desired impact.

The major driver behind recent market performance has been the AI and technology boom, with companies throwing massive amounts of money at processing power.  In the larger technology names, we have seen this AI spend have little negative impact on earnings growth, and they will be the first names to benefit if the thesis plays out.  The bigger question remains, how will AI spend be monetized outside of the technology sector? Will it simply be a new cost of doing business across all industries or will it materially drive growth and efficiency?  As we have seen during past transformative market cycles, like the internet in the late 90s, money flows to companies on the prospect of the technology and not necessarily the results.  As this technology revolution plays out, I expect there to be real winners and losers.  We could see some real volatility with the losers.

With the continued concerns around market valuations, which I have discussed in previous reports, earnings results continue to impress. For the third quarter, the S&P saw year-over-year earnings growth of almost 8% with the full year forecast sitting around 10%.  This level of growth has helped to dispel some concerns around stretched valuations. However, it is important to point out that an outsized amount of this earnings growth can be attributed to just a handful of mega-cap names.  They now make up such a large percentage of the S&P market cap that their performance can skew market-wide growth numbers.  If you carve out these mega-cap names, earnings growth is much lower.  I’m not saying the rest of the market isn’t growing, as 11 sectors have seen year-over-year earnings growth, but the actual participation may be lower than the overall number suggests.

The same logic can be attributed to market valuations as well.  With some of the largest companies growing the fastest and thus demanding a higher multiple, they will skew market multiples for the entire market.  If you look at the forward P/E ratio for the S&P, it sits above 22x, which puts it in the top 2-3% historically. If you exclude the Magnificent 7, this valuation drops down to around 20x. This multiple is still above long-term averages but is not nearly as stretched as the full S&P number.

The Fed also began its rate-cutting process in September, cutting rates by 25 basis points.  Markets are pricing in another 100 basis points of cuts over the next few months.  These cuts are dependent on inflation data continuing to come down, but the softening labor market seems to justify these moves.

The other major overhang in the fixed income markets is the fiscal deficit and the continued concern over government spending.  The Fed can continue to cut rates, but if the bond markets see increased risks due to overspending, then the impacts of cuts across the rate spectrum will be muted. Long-term, I think this is one of the largest risks to the domestic economy.  At some point, these debts need to be paid, and if rates remain elevated, servicing this debt becomes problematic. The big debate will be can increased spending help us grow our way out of this debt or will large-scale spending cuts be needed.  Neither side of the aisle looks too motivated to cut spending, and it has become such a political football that I expect very little to be accomplished.

With all of these variables in play, I expect volatility to increase over the next few months.  I wouldn’t be surprised to see some profit-taking in some of the high-flying names, which could put downward pressure on equity markets.  I think a pause or small pullback would be helpful for the overall market.  This would give some companies a chance to catch up to their multiple and give us more insight into how they will be deploying AI to grow their companies. I feel like I have been saying this same thing for quite some time, but staying invested is still appropriate, albeit with a defensive mindset.  I would be looking to use any new cash to shore up allocations and make sure the run-up in certain sectors has not skewed risk in portfolios. Now is not the time to chase.

Strategy Commentary

I continue to maintain my overall equity allocation targets.  Any changes were simply around rebalancing, as the large growth-oriented names have outperformed, and it was prudent to trim some and reallocate in other areas.  With markets continuing to hit all-time highs, I have been patient with any new money and have been building out allocations much more slowly than in other market environments. In hindsight, I should have put more cash to work back in April, but the risk profile of the markets at the time was not promising.

Domestically, I continue to maintain my overweight to technology and communication services.  These sectors have been spending the most on their AI buildout, but have also been seeing the most robust earnings growth. I have trimmed these positions slightly, especially with clients that have any highly concentrated positions, as the outperformance in these sectors has led to too large an overweight.  I have started to increase exposure to small and mid-cap names.  I have not moved to overweight in these areas, but think they currently provide the best valuation opportunities.

Internationally, I have been a little late to reallocate dollars.  I still have a neutral weight to both developed international markets and emerging markets.  These regions have outperformed, even in the face of geopolitical uncertainty, and I have missed out a bit.  I do think the emerging markets story, especially in China, continues to have legs, and I will be looking to add to this region if the opportunity presents itself.

On the fixed income side, I am still maintaining more of a barbellled approach.  I am comfortable holding an increased amount of short-duration funds as I wait to put new money to work. I also have exposure at the longer end of the curve to take advantage of any continued drop in rates.  If there is a rush to safety and the Fed is forced to cut rates more aggressively, then the longer end of the curve will benefit.

Click here for the .pdf version of this report: The Brave Report-2025Q3