The Bull Marches On

The third quarter of the year was another good period for the equity market. The Dow Jones Industrial Average rose 5.2%, the benchmark S&P 500 Composite index gained 7.8%, the Nasdaq Composite index increased 11.2% and the broader small capitalization Russell 2000 index generated an impressive 12.0% gain. The SPDR S&P Semiconductor ETF (XSD – $319.12) was a standout with a 24.4% gain in the quarter. Note that three stocks, Meta Platforms, Inc. (META – $743.38), Alphabet Inc. A (GOOGL – $243.10), and Alphabet Inc. C (GOOG – $243.55), represent more than 28% of this sector’s total weighting. By the end of September, the year-to-date gains in the indices were 9.1% in the Dow Jones Industrial Average, 13.7% in the S&P 500, 17.3% in the Nasdaq Composite index, and 9.3% in the Russell 2000 index. In short, 2025 has been an excellent year for equity investors.

Shutdowns and Debt Ceilings

However, as we go to print, it appears that Congress may not be able to pass a clean continuing resolution bill (CR) to keep the government open for another seven weeks. This means the US faces a government shutdown on October 1 (the beginning of a new fiscal year). Although a government shutdown is not a good thing, the October 1^st deadline does not create an immediate threat to the equity or fixed income markets.

A federal shutdown halts, or postpones, discretionary government spending; however mandatory payments, including interest payments on US Treasury securities, Social Security, Medicare, and Medicaid payments are legally required to continue. Normally a continuing resolution bill will also include an increase in the debt limit; but the budget reconciliation law enacted on July 4, 2025 (known as H.R.1 – One Big Beautiful Bill Act) raised the debt limit by $5 trillion to $41.1 trillion. This was an important inclusion in the July 4^th bill since it will allow the US Treasury to continue to issue debt and pay all its mandatory obligations without fear of reaching the debt ceiling in the near term. Had the debt ceiling not been lifted in the One Big Beautiful Bill Act, it could have been breached, and the US Treasury would have had to employ unusual means to pay interest on its debt, if possible. The prospect of a default on US debt would have thrown the fixed income markets (and in turn the equity market) into chaos in the fourth quarter. (Note: debt held by the public was $30.1 trillion and intragovernmental debt was $7.3 trillion, for a total outstanding debt of $37.4 trillion, as of September 3, 2025.)   

the federal reserve and the bls

The long-awaited September Federal Reserve meeting delivered the 25 basis points cut in the fed funds rate as expected. The previous rate cut was 50 basis points in September 2024. History shows that stocks tend to perform well in the six and nine months following a first rate cut, and not surprisingly, equities rallied in anticipation of this event. The Wall Street adage “Don’t Fight the Fed” is based upon historical data that shows that equities perform poorly when the Fed is raising rates but perform well when the Fed is lowering rates.

One reason we expect the Fed will continue to lower interest rates this year is that the labor market may be weaker than previously reported. The Bureau of Labor Statistics recently announced that the annual revision to payrolls in the 12 months ending in March 2025 is estimated to be a subtraction of 911,000 jobs. This means payrolls were lower than previously reported and actual job growth may have been 76,000 jobs less than reported for every month from March 2024 to March 2025.

This annual adjustment was far larger than economists anticipated, and it appears to be the largest revision ever recorded. Moreover, it would be the second huge annual revision in a row. Our concern is that job growth might have been, or is, negative on a year-over-year basis. Negative job growth is closely aligned with an economic recession. Unfortunately, the BLS will not confirm this estimate until next year. But we believe the Fed should continue to lower rates or risk being too late once again.

Equally important, in the third quarter the consensus view that tariffs would trigger high inflation and a weak economy finally began to fade and analysts became less bearish. In our opinion, the most important event of the third quarter was second quarter S&P 500 earnings results, which were expected to increase by less than 5% YOY, but actually grew 10.5% YOY. Not only was this a positive surprise, but it means that earnings were growing well above the long-term average of 8.2% YOY.

Equity valuation is high but…

There are many possible hurdles facing the financial markets in the fourth quarter including conflicts in the Middle East and Europe, political division domestically, and sovereign deficits here and in Europe that threaten fiscal stability. However, in October, aside from the FOMC meeting, the most important factor may be the start of third quarter earnings season. Underlying all bull markets are solid fundamentals. The current IBES LSEG consensus earnings forecasts for S&P 500 earnings are $266.67 for 2025 and $304.40 for 2026. This means that the market is trading at 24.9 times this year’s earnings and 21.8 times 2026 earnings. This is rich by most historical measures. Nevertheless, the 2026 S&P 500 earnings yield is 4.6%, and when coupled with the S&P 500’s dividend yield of 1.2%, the combination remains attractive relative to the 10-year Treasury yield of 4.1%.

Moreover, we expect earnings will continue to surprise on the upside due to a stronger economy. What most strategists have overlooked is the stimulative impact of fiscal policy which allows large and small businesses to fully depreciate investments in the current year. Early next year we expect many households will benefit from the reduction of taxes on tips, social security, and overtime, and special deductions on car loan interest and a $6,000 deduction for eligible seniors. In sum, while markets may remain volatile, we expect the bull market will continue.

*Stock, index, and sector prices are as of September 30, 2025

Gail Dudack, Chief Strategist

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