Fed Policy, Strong Earnings, and Shifting Momentum

Large-cap growth stocks (Russell 1000 Growth) were up 10.51% nearly doubling value stocks’ (Russell 1000 Value) 5.33% gain. Small-cap stocks (Russell 2000) had a strong quarter (up 12.39%), outperforming large-cap stocks amid hopes that lower interest rates would benefit the asset class.

Internationally, developed market stocks (MSCI EAFE) gained 4.77% in the quarter, lagging the S&P 500. Emerging markets rose 10.64% (MSCI EM) in the quarter largely because global financial conditions are easing, valuations are relatively attractive, and there is AI optimism in key markets, especially China. Year to date, developed international and emerging market stocks are still outperforming domestic stocks, thanks to a roughly 10% decline in the U.S. dollar.

In the U.S. fixed-income market, after holding rates steady for the first eight months of the year, the Federal Reserve resumed rate cuts in September. The Fed stated the cut was “risk management,” taking a more cautious stance toward slowing growth and softening labor conditions. Yet the path forward remains far from certain. While the Fed emphasizes data dependency and balancing the risks of inflation versus economic growth, markets are pricing in a more aggressive easing trajectory. Against this backdrop, yields moved unevenly across the curve. Credit markets remain strong with spreads near multi-decade tights, and fiscal pressures continue to influence long-term rates. Investment-grade core bonds ended the quarter up 2.03% (Bloomberg US Aggregate Bond), while high-yield bonds were up 2.41% (ICE BofA US High Yield).

Markets are always reacting to news, but today it feels even more pronounced. Every data release, policy comment, or geopolitical headline seems to carry an outsized influence on investor sentiment. This heightened sensitivity seems justified, as investors try to determine the path forward. Will the economy continue to slow under the weight of tighter financial conditions, or can momentum continue?

Against this noisy backdrop, there are reasons for optimism. One important tailwind comes from monetary policy. The Federal Reserve’s recent rate cut, after a prolonged pause, provides a constructive backdrop for both equities and bonds. Lower rates reduce borrowing costs for consumers and corporations, potentially fueling further investment and spending. History also offers perspective. A study by J.P. Morgan found that when the Fed cuts rates with the S&P 500 within 1% of an all-time high, the index has averaged a 15% gain over the following 12 months.

The consumer also remains a source of strength. The U.S. economy is primarily driven by consumption, often described as the backbone of growth. Spending has held up well across much of the economy, even after adjusting for inflation. While income and spending levels are not distributed equally, i.e., there are meaningful disparities across households, overall consumption has been supported by real wage growth that has outpaced inflation in many segments. This has enabled households to absorb higher costs without meaningfully pulling back. Balance sheets, meanwhile, remain generally healthy, the result of higher brokerage accounts and stable housing values. Despite higher mortgage rates, housing continues to serve as a source of household wealth and an important piece of consumer confidence.

Corporate fundamentals add another layer of support. Earnings growth rose 11.7% in the second quarter, making it the third consecutive quarter of double-digit growth. Many companies reported expanding margins, improved efficiency, and positive forward guidance. These results provide a foundation for higher equity valuations.

Importantly, market leadership has begun to broaden. While much attention has been focused on a handful of large-cap technology companies, gains have recently extended across a wider set of sectors. This improved breadth suggests a healthier rally, less reliant on a narrow cohort of stocks.

Of course, risks remain. We are closely monitoring the labor market. Key indicators such as quit rates, layoff rates, and initial unemployment claims have all flatlined. We seem to be at stall speed, and conditions could shift either way, so we’re monitoring developments closely, especially the unemployment rate.

Since April, job gains averaged around 53,000 per month, which aligns closely with estimates of breakeven job levels needed to keep unemployment steady. We are not yet seeing broad-based layoffs or the kind of deterioration that typically signals an outright downturn. In the table below, we show some current key labor market stats compared to prior periods.

Deciphering the job market data is not as easy as reading the headlines. In recent years, immigration has led to large swings in labor supply and distorted the relationship between payroll growth and unemployment. When labor supply expanded quickly in 2023 and 2024, job gains looked strong but were outpaced by labor force growth, leading to higher unemployment. Conversely, when supply growth slowed in late 2024 and early 2025, job growth weakened but the unemployment rate held steady. More recently, employment growth has slowed further, yet the number of job seekers remains roughly in line with available jobs. The key point is that payroll growth can look strong when conditions are deteriorating and appear weak when the market is relatively balanced. Today’s combination of modest job growth and a stable unemployment rate suggest the labor market is slowing but not collapsing. We continue to watch the data closely for signs of further weakening.

In short, while near-term uncertainty can test long-term conviction, we believe this environment highlights the importance of discipline. Staying focused on fundamentals and resisting the temptation to be swayed by short-term noise remains the most effective approach to navigating today’s markets.

We enter the final quarter of the year with both opportunity and uncertainty. Equities are supported by resilient earnings, healthy consumer demand, and a more accommodative Fed, yet valuations remain elevated, and policy debates loom large. In fixed income, tight spreads reflect strong corporate fundamentals even as fiscal pressures and policy divergence create risks at the long end of the curve. Labor markets are softening but not collapsing, reinforcing the view that growth is slowing rather than outright stalling.

This is a moment to stay disciplined. Near-term volatility and policy noise will likely continue, but fundamentals (i.e., healthy balance sheets, consumer spending, and improving breadth in equity markets) provide a constructive backdrop. We continue to maintain diversified portfolios, balancing risk and opportunities, and positioning to benefit from long-term secular trends while staying alert to evolving macro and policy risks.