Market Commentary Q3 2025 – Tech Spending Fuels Growth & Sentiment
The S&P 500 finished the third quarter up 14% year-to-date, and nearly 35% from the April 8th bottom. From the lows in October 2022, the index has now doubled on a total return basis. Supported by the resilience of corporate earnings and the tailwind of artificial intelligence spending, investor sentiment appears to have shifted back to risk-on.
To this point, most of the capital deployed, or to be deployed, towards AI infrastructure has ostensibly come from the robust cash flow of mega-cap tech companies. During the quarter, leverage was added to the equation, following the seminal announcement from OpenAI and their debt-fueled partnership with Oracle. While accelerating capital spend is seen as a necessity by the various tech leaders to maintain or improve their competitive “moats”, risks from excess spending, both private and public, appear to be increasing.
At some point, companies will need to justify the returns on these extraordinary investments to shareholders. Up until now, the largest technology companies have been widely viewed as capital-light, cash-generative, which makes the hurdle rate for returns on these investments that much higher. For now, they seem to be getting a free pass in funding what appears to be a race to superintelligence.
The U.S. economy is largely dependent on consumers, which generate nearly 70% of gross domestic product (GDP). Yet, so far this year, capital spending in data centers has provided a comparable level of economic output. The accelerated investments by technology companies in cloud infrastructure and artificial intelligence has created a potential tailwind for economic activity and corporate profits. Thus far, those profits are primarily accruing to the technology companies involved in the infrastructure build-out. In theory, this may eventually lead to broader economic productivity and corporate profitability.
Consumer spending has been somewhat of a corollary to the concentrated nature of the stock market, in that the top end of the consumer is exhibiting much better behavior than the bottom end. The top 10% of the income distribution accounted for 49% of consumer spending in the second quarter. Low-income consumers are beginning to pull back on spending, likely due to a slowing labor market, sticky inflation and housing affordability. Upper-income household spending remains more resilient, likely supported by the “wealth effect” of higher home prices and a strong equity market.
The employment market, one of the more reliable forward-looking indicators for the economy, is sending cautionary signals. Unemployment spells are lengthening as job seekers struggle to find new opportunities, while job openings continue to trend lower. A weakening employment backdrop has given the Federal Reserve cover to resume rate cuts once again, which they did in September. The market is currently pricing in one additional rate cut in 2025, followed by further accommodative policy in 2026.
Corporate earnings have maintained their resilience, despite the uncertainty around tariffs. Second quarter results for S&P 500 companies vastly exceeded expectations, with 12% growth vs. the 5% expected as of June 30th. While we have expected earnings and overall market breadth to improve, the majority of growth is still coming from the largest companies in the index, which has led to further concentration in the makeup of the S&P 500. As of September 30th, the top 10 companies comprised over 40% of the index.
From a valuation standpoint, the spectrum continues to widen. U.S. large-cap stocks trade at a significant premium to small and mid, which is at least partly justified by relative earnings strength. International equity valuations, while still mostly lower than the U.S., have meaningfully expanded year-to-date. Along with the dollar decline, this has led to significant outperformance of international stocks over the past year. Earnings may be expected to improve abroad, but returns have thus far come primarily from valuation expansion and currency translation. Over the long term, we believe earnings growth is the most important driver of equity market performance.
More recently, we have started to observe an increase in investor speculation, including the relative performance of non-profitable technology companies. Momentum stocks have also meaningfully outperformed those exhibiting both quality and value characteristics over the past year.
While we need to be mindful of such speculative activity, we prefer to focus on the quality and earnings durability of the businesses we own or are likely to own. For the most part, those companies have executed better than our expectations coming into the year. In our opinion, the bar seems to be higher as we look out into 2026, which is requiring us to act with additional diligence and patience.
Authored by: Jack Holmes, Chief Investment Officer
DISCLOSURES: Thought Leadership Disclosures
