Market Commentary 3Q 2025

In the 3rd quarter, the markets continued to perform well. Large US companies led the way with an 8%+ return, but small and international companies were not far behind. It appears that times are certainly good for stock investors!

However, I believe a dose of caution is in order. Stock valuations have stretched beyond historical norms. Especially in the US. And especially for large companies.

One key tenet of investing = all else equal, higher prices mean lower future returns. In the chart below, the Schiller CAPE ratio – a price-earnings ratio using the average of the past 10 years of stock market earnings – is approaching levels not seen since the dot-com bubble in 1999.

High valuations could represent a significant risk for stock market returns over the next 5-10 years. Those reading this may not remember, but after the dot-com bubble burst, the S&P 500 had a return of essentially zero – that’s right, zero – over the 13 years from 2000-2013 (partly due to the financial crisis in 2007-2009).

However, as long term investors, we must be comfortable with assessing the risks in our portfolios and making changes when necessary. One question I like to ask people is, “How would you feel if your stock portfolio got cut in half tomorrow?” The responses generally range from “mild anguish” to “inconsolable” to “why the hell are you asking me that?” The stark reality is that long term investors must expect to absorb and be able to tolerate losses of at least 50% in their stock portfolios. And to be clear, a 50% draw down is the expected or base case – not the worst case! If you cannot honestly tolerate a 50% loss in your stock portfolio, then it’s likely time to reduce risk.

Obviously, I could be wrong about future returns. My crystal ball is cloudy after all. The important thing to remember is avoid complacency when markets are doing well.¹

Economic update

The economy continues to chug along, albeit with some concerns in the labor markets. Ongoing immigration enforcement, tariffs, and the realignment of the federal government have all combined to stall hiring across various sectors. It remains to be seen whether these are short term hiccups or long term structural issues in the labor markets.

In response, the Federal Reserve Board acquiesced to lower interest rates in September with a 0.25% cut. Likely we can expect at least one more 0.25% cut before year end.

One thing to keep an eye on is the US dollar’s standing in the world. 2025 has been a tough year so far for the dollar, with a year-to-date decline of ~10%.

For US investors, a declining dollar represents a headwind to long term prosperity. As Warren Buffett said earlier this year, “We wouldn’t want to be owning anything that we thought was in a currency that was really going to hell, and that’s the big thing we worry about with the United States currency.”

On the political front, President Trump has indicated a desire to drive the dollar lower in an effort to make our exports more attractive on the international market. Deficit spending also has likely hurt the dollar. The current US federal spending deficit is ~6% of GDP. Many economists believe the deficit must move closer to 3% of GDP to provide long term support for the dollar.

Tax/planning updates

Congress passed the OBBBA over the summer. You can read my thoughts on the OBBBA tax changes here and here. As part of year end tax planning, I encourage all readers to learn about the OBBBA and the potential effects on your tax return for 2025 and beyond. I’ve already started incorporating the changes into my discussions with clients, but if you have specific questions or concerns, feel free to reach out.

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¹ And to not lose hope when markets are crashing!