CAPITAL MARKETS REVIEW - October 2025

CAPITAL MARKETS REVIEW - October 2025
Jay Ratterman, CFA
Private Wealth Advisor/Partner

Q3 2025: AI Drives Market Momentum, Fed Pivot Lifts Small Caps

The third quarter saw the stock market successfully carry its strong Q2 momentum forward, driven almost entirely by the relentless artificial intelligence (AI) trade. Mega-cap technology names, including Apple, Alphabet, and Nvidia, were the primary catalysts, powering the S&P 500 Index to an impressive 8.1% quarterly gain. The Technology sector was the largest single contributor, responsible for over half of the index's performance, a result of its strong absolute return (+13.2%) and its dominant 34% weight in the index. The performance concentration remained stunningly high: the top three positions (Nvidia, Microsoft, and Apple) drove over 37% of the S&P 500's return, while the ten largest companies, representing 39.3% of the index by market capitalization, collectively accounted for 71% of the total Q3 return. In contrast, Consumer Staples was the only sector to post negative performance, dragged down by lingering worries over tariffs impacting profit margins and a market preference for growth oriented sectors like Tech and Communication Services, both benefiting from the AI enthusiasm. Outside of the large-cap dominated S&P 500, US small caps experienced a powerful rally, hitting all-time highs and generating a quarterly return of over 12%. This small-cap resurgence was fueled by AI-connected names and the commencement of a potential rate-cutting cycle, as the Federal Reserve lowered rates in September for the first time in over two years. This shift— driven by waning inflation concerns and emerging job market wobbles—is a significant boon for small-cap companies, which typically carry higher debt loads and stand to benefit most from reduced debt servicing costs.

Q3 2025: International Markets Performance

As investor attention remained focused on the massive US tech rally, international markets saw more muted returns in the third quarter compared to their blistering rally in the first half of the year. China was the strongest performer, with mainland markets climbing 20.1% for the quarter. This significant surge was largely a result of optimism surrounding China's own advancements in AI and a concentrated policy push by the government to stabilize equity markets. Canadian markets outperformed the US with gains of 10.4%, and Japanese markets returned 8.0%. Meanwhile, European markets lagged behind, with the MSCI Europe ex-UK Index delivering a comparatively modest 2.8%. European stocks struggled under the weight of weak corporate earnings revisions and uncertainty stemming from domestic political instability and a persistently slow economic growth outlook. The depreciation of the US Dollar during the first two quarters of the year provided a strong tailwind for international stock returns for US investors, but that benefit was neutral in the third quarter, with the US Dollar Index flat. Despite Q3 returns being below US large-cap figures, international stocks as a whole are still outpacing their US counterparts since the start of 2025.

Q3 2025: Yield Curve Steepens Following Fed Rate Cut 

The third quarter brought significant changes to the fixed income landscape, marked by a distinct steepening of the US Treasury yield curve. This steepening occurred as short-term interest rates fell this summer in direct response to the Federal Reserve's first rate cut in over two years, while long-term rates declined too, though not as dramatically. The yield curve is a graphical representation of government bond yields across different maturities, and it measures how much compensation bond investors expect for the extra risk of having money locked up with the federal government for longer periods. A steeper curve, in this instance, signifies that investors are demanding relatively higher yields for longer-dated bonds compared to shorter ones. Overall, the fixed income market realized positive returns, benefiting from the general drop in rates. The Bloomberg US Aggregate Bond Index posted a gain of 2.0%, with riskier segments like High Yield Bonds again leading the way, suggesting continued investor confidence in corporate credit despite economic uncertainty. Municipals, a laggard for much of the year, saw a strong rebound during the quarter as investors took advantage of attractive relative valuations versus comparable Treasuries.