Upside Surprise
As we entered the second quarter of 2025 the Bloomberg survey of economists forecasted the U.S. economy to grow 1.9% for the impending three-month period. We were about to experience the Liberation Day announcement clarifying tariff policy and the uncertainty level was high. Compounding the uncertainty was the fact that first quarter GDP growth registered a slightly negative result which made forecasting a second quarter result even more challenging. To see the recently announced final report that second quarter GDP came in at a much more robust level of 3.8% was a welcome surprise. The primary drivers for the quarter’s strength were a higher than anticipated level of consumer spending and a significant decrease in imports. Consumer spending continues to be supported by an ongoing wealth effect attributable to a continued increase in stock prices and the heightened level of equity for homeowners as home values appreciated significantly over the past few years. Reflecting the opportunity for homeowners presented by higher values is the increase in the demand for Home Equity Lines of Credit (HELOC) where homeowners are borrowing against the increased value of their homes to purchase goods and services or to make new investments. The most recent report of retail sales provides support to this scenario as the report for the month of August showed increases that exceeded expectations as well as the results for the prior month.
Rate Cuts on the Horizon
With the Federal Reserve reducing the Fed Funds rate in September there is currently an expectation of further cuts at their October and December meetings. Key considerations for potential future cuts, as has been widely documented, will be future inflation readings and employment levels. Inflation has moved higher recently with the Consumer Price Index (CPI) registering a year-over-year rate of 2.9% in August. The rate is anticipated to move slightly higher going forward as the full impact of tariff increases work their way through the economy. Once that process has been completed, further increases in the rate of inflation are not anticipated. While headline numbers pertaining to employment data continue to point to a relatively stable environment, there is growing concern regarding the prospects for the labor market. Although headline numbers such as the Job Openings and Labor Turnover Survey (JOLTS) report and unemployment rate have shown little movement of late, recent consumer confidence surveys are indicating mounting concern. Specifically, the Conference Board’s most recent report of consumers’ assessment of job availability fell for a ninth straight month. We do anticipate we will see some uptick in unemployment but currently do not anticipate a substantial increase from current levels. Concern regarding the labor market was the key factor in the most recent rate cut and if that concern is ongoing the likelihood of the anticipated rate cuts over the next months will become even more solidified.
Fourth Quarter Outlook
As we transition into the fourth quarter, the U.S. economy is forecast to register growth of 1.7% for the quarter just ended and an even more modest result of 1.2% for the final quarter of 2025. Of interest regarding this outlook is the most recent release from the Atlanta Fed which, through their GDPNow analysis, suggests third quarter growth could be a much more robust 3.8%. As of this writing, with a government shutdown currently in place, actual results for the economy could differ from those that were previously anticipated. We are already seeing a temporary cessation in the reporting of various economic data.
Asset Allocation
In equity markets, the Russell 3000 Index gained 8.2% this quarter to bring the year-to-date advance to 14.3%. Third quarter strength was bolstered by growth projections of future Technology sector earnings. Overseas markets, as measured by the MSCI ACWI ex U.S. Index, advanced 7.1% this quarter with a significant contribution from a 10% year-to-date drop in the U.S. Dollar Index.
U.S. Bond markets continued to advance during the quarter adding a 2.1% return for the quarter and 6.2% for the year. Declining inflation expectations helped lower interest rates across the curve, boosting bond prices. Corporate bond prices have continued to improve to the point where meaningful price gains from improving credit conditions are not expected. We still favor investment grade credit as corporate balance sheets remain solid with low leverage and interest cost on balance sheets.
In our asset allocation positioning, we maintained the neutral status for each of our seven investment objectives relative to their respective static benchmarks. These seven objectives offer a full range of risk and return profiles. For investors whose portfolios include an active management component, neutral comes in various shades. The weighting of growth versus value stocks had an impact this quarter as the Russell 1000 Value Index advanced 11.5% versus 17.2% for the Russell 1000 Growth Index. Decisions of what size of firm to hold influenced returns as small capitalization stocks advanced 12.4% versus a negative return during the first half of the year. Finally, country selection had a significant impact on Generation Alpha during the quarter as both developed and emerging markets adjusted to a recalibration of trade and domestic growth factors.
With the Russell 3000 Index selling at 26 times forward earnings and equity markets posting an average 23.7% annual return for three years, investors recognize the potential problem that an unexpected event could cause in terms of derailing this momentum. While valuations are high on a historical basis, as our equity team has noted, the growth prospects for corporate earnings remain strong. In this environment our allocations still favor U.S. large cap equities and high-grade bonds as they provide the right balance of positive outlook for returns and the ability to recover from potential market pullbacks.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.