September shook off its reputation as the weakest month of the year as both US and rest of world stocks enjoyed solid gains during the month. The Emerging Markets index posted gains of more than +7%, as Chinese tech stocks exposed to the AI theme pushed higher. The S&P 500 was up 3.65% on the strength of tech stocks. The Russel 2000 small-cap index couldn’t match large-cap gains, but it did manage to post its first new all-time high in four years. For the quarter, US stocks outperformed rest of world stocks for the second quarter in a row, and the US dollar outperformed other currencies. Emerging markets meaningfully outperformed Developed Non-US stocks in the quarter, marking a potential shift in investor allocations from Europe to emerging markets.
The Federal Reserve cut the Fed Funds rate in September for the first time since December 2024. Citing concerns about both weak employment and the potential for reaccelerating prices, the Fed determined that preventing further weakness in employment was the priority for now. US Treasury rates exhibited increased volatility after the decision, but ultimately moved lower in the month, pushing the Bloomberg Aggregate Bond index higher. Credit spreads remained tight and currency markets were calm by recent standards, posting slight gains for the US Greenback. Gold markets, however, moved sharply higher, setting yet more price records. Silver followed the yellow metal higher and reclaimed prices not seen in over 14 years. Oil prices fell a further -2%, easing inflation fears.
The following table contains a summary of September and year-to-date market performance:
| Index | September | YTD | Index | September | YTD |
|---|---|---|---|---|---|
| S&P 500 (Total Return) | +3.65% | +14.83% | MSCI All Country World (Net) | +3.62% | +18.44% |
| MSCI EAFE (Net) | +1.91% | +25.14% | Bloomberg Barclays US Agg | +1.09% | +6.13% |
| MSCI Emerging Markets (Net) | +6.96% | +25.16% | 60/40 Blend* | +2.61% | +13.60% |
* 60% All Country World Index / 40% Bloomberg Barclays US Aggregate Bond Index
Looking back at our December 2024 monthly commentary, we noted that the US economy was in a period of mid-cycle economic growth. These periods are often accompanied by volatile and contradictory economic data, generally improving corporate earnings and stock markets that grind higher. Our primary concerns at the time were rooted in the slow but persistent deterioration in labor markets, elevated stock market valuations, and the high concentration of returns among the largest tech names. Our advice to clients was to remain disciplined since mid-cycle periods can last for an indefinite period of time, and exiting markets too early can be costly. Nine months later, as we write the September 2025 commentary, we find ourselves tempted to simply reissue the December commentary and see if anyone notices.
Of course, there have been many important developments over the first three quarters of 2025, but our core observations regarding where we are in the economic cycle and risks remain strikingly similar. In fact, P/E ratios and market concentrations are higher today than they were at the beginning of the year. Meanwhile, the leading and cyclical economic indicators point to a still fragile and deteriorating economy. Readers will be excused if they wonder how it is that we might characterize the economy as fragile when the Fed’s GDPNow estimate for Q3 economic growth is projecting a +3.9% growth rate after a strong +3.8% in Q2.
To be sure, we are encouraged by the sharp and sustained GDP growth in the US economy after the mild contraction in Q1 – and we are somewhat surprised by how much economic strength is reflected in the numbers, especially after the disruptions caused by the chaotic rollout of tariffs on Liberation Day. As a reminder, full mid-cycle transitions are usually characterized by positive but moderating growth from the rapid rebound seen in early-cycle periods. However, much of the growth is directly attributable to the infrastructure build-out required by the AI boom. These enormously ambitious projects, being undertaken by some of the largest and most profitable companies in the world, are substantially responsible for the upside growth surprises we have enjoyed. It remains to be seen if this boom in spending will be sustained or if these investments will turn out to be good investments, but there is no doubt that the investments in data centers, computing, and electrical generation are contributing to current economic growth.
But below the strong growth headlines is less encouraging data that points to important sectors of the economy remaining under considerable pressure. The manufacturing sector has been in contraction for most of the last three years, and commercial real estate, hit hard by work-from-home policies during Covid, remains burdened by debt and low office occupancy. More recently, new home permits have hit new lows, keeping pressure on construction, and cyclical employment has started contracting for the first time since the peak of this current cycle – a signal that often precedes recession. If cyclical declines deepen, broader weakness will follow.
The future of the cyclical economy may rest in the hands of the Federal Reserve, which cut the Fed Funds rate in September for the first time since December of last year. The Fed finds themselves caught on the horns of their dual mandate of promoting both full employment and stable prices. After cutting rates aggressively in the last few months of 2024, the Fed paused – first in response to a bevy of pro-growth policies which the Fed feared might overheat the economy and ignite inflation, and then in response to the imposition of tariffs in April, which the Fed also feared could lead to inflation. However, with the recent weakness in the labor market, the Fed determined that it was time to resume cutting to support a recovery in the cyclical economy, including in the manufacturing and construction sectors, in an effort to arrest further labor market deterioration. We think they made the right decision and expect that they will continue to cut interest rates in the coming months.
In past letters, we have commented that the economy will have achieved a soft landing when the leading and cyclical economic indicators turn higher. This has not happened yet. However, with the Fed once again cutting rates and significant fiscal stimulus provided in the recently passed budget bill targeting manufacturing and construction with generous accelerated depreciation provisions, it is possible that the Fed may still navigate the US economy to a soft landing and avoid a recession. If the combination of these tools work, we should see it in future improved readings of leading and cyclical measures of the economy. In that scenario, the US economy could experience a productivity boost in 2026 and continued GDP growth. However, we are mindful of the potential for policy overshoot where an uptick in economic growth could lead to future potential price pressures.
So, how should clients navigate this environment? First, recall that timing markets is ferociously difficult. This is why our portfolio management philosophy emphasizes process over prediction. At the current high valuations, we believe there is a lot of good news priced into equity markets. Continued equity gains will require many things to go just right. Therefore, we recommend staying close to target allocations in public equities. We also recommend raising cash for any large, near-term expenses (next 6 months or so). Second, if the US experiences a recession or a market pullback, be prepared to add to equities so your portfolio is well-positioned to benefit from the eventual recovery.
What we’re reading:
Below we share a glimpse into the books currently capturing the interest of the Caprock team – highlighting the diverse tastes and curiosity that drive our team.
Jay Page, a Managing Director located in the Caprock Chicago office, is currently reading the following books:
- Churchill’s War – Volume 1: The struggle for power by Winston Churchill: This book dives into Winston Churchill’s rise during the inter-war years, focusing on his political battles and ambitions, as he navigates chaos and rises to leadership just as World War II erupts.
- The Bitcoin Standard by Saifedean Ammous: This book explores Bitcoin as a decentralized digital currency, arguing that it could serve as a superior alternative to traditional fiat money due to its fixed supply and resistance to inflation.
- Behavioral Game Theory: Experiments in strategic interactions by Colin Camerer: This book studies how real people make decisions in strategic situations. It explores how emotions, biases, and social factors shape those interactions.
This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but Caprock makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.