By: John Terrill, Senior Vice President, Trust Officer, and Wealth Advisor & Investment Committee Chair

By: Toby Marks, Senior Vice President, Chief Investment Officer & Portfolio Manager

Market Performance & Trends

Stocks entered the 3rd quarter with the continued momentum from the V-Shaped rally after the tariff announcement on Liberation Day, April 7. While there were changes in leadership throughout the quarter, in the end, it was the continued outperformance of large cap growth stocks, which once again, led to positive returns for U.S. stocks. Momentum carried through the end of the quarter as the S&P 500 experienced its 2nd best September in 27 years. Internationally, emerging markets stocks have garnered the top spot in YTD returns. Small cap stocks, one of the few groups of stocks to be considered undervalued, did outperform the overall market in the 3rd quarter, and reached new highs for the first time since November 2021.

Economic Landscape

The 10-year U.S. Treasury traded in a tight range for the quarter, moving from a yield of 4.23% at the beginning of the 3rd quarter to a yield of 4.15% to end the quarter. The 10-year briefly traded at a yield below 4% in September for the first time since April. The Federal Reserve did cut the Federal Funds rate in September for the first time in 2025 by 25 bps. Fed Chair Jerome Powell cited this decision as the “middle path” between persistently higher inflation and a softening labor market. In September, the Bureau of Labor Statistics, revised downward the number of jobs created from April 2024 to March 2025 by 911,000. This adjustment, along with average payroll growth of only 29,000 jobs per month in June, July and August, forced the Fed to consider a rate cut, and set the stage for either one or two additional cuts at the two remaining meetings in 2025. The Federal Reserve now has the difficult task of juggling their dual mandate of maximum employment and stable prices. Throughout the 3rd quarter, trade policy was altered with the implementation of reciprocal tariffs on specific countries and special tariffs on certain product categories like steel, aluminum and autos. As the tariff program was implemented over multiple months, the inflationary impact has been muted or minimal since additional tariffs began in the 2nd quarter. GDP for the 2nd quarter was strong at 3.8%, after a first quarter GDP of -0.5%. The first two quarters of 2025 should not be analyzed separately, as the front loading of imports preparing for higher costs due to tariffs in the first quarter reduced GDP in the 1st quarter and increased GDP in the 2nd quarter. At this time, the Federal Government has shut down due to inability to pass funding legislation required to finance the federal government prior to the beginning of the next fiscal year. While the economic impact from the shutdown cannot be measured at this time, historically this has had very minimal effect on GDP.

Investment Committee Update

There were no significant portfolio adjustments recommended by the committee. Significant exposure in the International portion of the portfolio led to enhanced returns during the quarter. Also, the small cap stock allocation achieved better then market performance as the Russell 2000 was the highest performing index during the 3rd quarter.

Investment Outlook

As the 3rd quarter closed, we are left with a stock market that seems to be overvalued, by many accepted historical measurements. The S&P 500 currently trades at 23.0x earnings. The 10 year average is 19.0x and the 20 year average is 16.4x.  The equal weighted S&P index is more reasonable at 17x earnings, eliminating the outsized impact of the large cap tech titans dominating stock market indexes. At this time, the markets are expecting the Federal Reserve to continue cutting the federal funds rate to provide additional stimulus to the U.S. economy. If, for some reason, the Federal Reserve does not follow through as expected, the stock market would react negatively in response to a “no cut” meeting.