Third Quarter 2025: All That Glitters Isn’t Gold
Submitted by Alsworth Capital Management, LLC on October 24th, 2025
Market Recap
Markets were strong, pretty much across the board, in the third quarter. Despite an uptick in inflation from tariffs, a government shut down, weakening labor markets and continued geopolitical unrest, the global markets have thus far been remarkably resilient. U.S. large cap stocks (S&P 500 Index) gained 8.1% in the last three months, bringing the year-to-date return to just shy of 15%. US small company stocks (Russell 2000 Index) gained over 12% on the quarter, largely driven by hopes that the Fed would continue to lower interest rates and spur economic growth through cheaper borrowing. Lower rates tend to disproportionately help smaller companies. The index of small companies recovered from a negative first half and is now up 10.5% year-to-date. Developed international stocks (MSCI EAFE Index) gained 4.8% for the quarter and are up over 25% year-to-date. Emerging market stocks (MSCI EM Index) were the standout stock market performer, returning 10.6% over the quarter and bringing the year-to-date return to 27.5%. Investment-grade core bonds (Bloomberg US Aggregate Bond Index) finished the quarter up 2.0% and up 6% on a year-to-date basis. Gold advanced 16.7% over the quarter and registered an impressive 47% gain year-to-date.
Investment Outlook and Portfolio Positioning
Markets have shrugged off the second quarter tariff uncertainty and have settled on the notion that the negotiations will result in something less dramatic than the initial threats. Current market expectations are that the inflation impact from tariffs will be a one-time hit to prices that consumers can manage through. So far, this is bearing out in the numbers. Inflation remains higher than the Federal Reserve’s target, but consumer spending still remains strong, especially from higher income consumers. However, lower income households are showing signs of stress, as cash savings have declined to below pre-pandemic levels. Default rates on student loans, credit cards and home equity loans are all elevated and trending higher. The job market has been weak, with low levels of hiring. Fortunately, there has also been very little firing. Employers are reluctant to let employees go, out of concern that it could be difficult to find workers again if the economy recovers. We have been able to avoid a recession, so far, because there are no significant layoffs. The persistent spending from higher income households has been enough to help corporations maintain high profit margins and earnings grew nearly 12% in the second quarter. This was the third consecutive quarter with double digit profit growth.
Most of the positive economic activity in recent quarters has been driven by investments in Artificial Intelligence (AI) within the technology, energy and infrastructure sectors of the economy. This is the markets latest glittering shiney object to fixate on. The largest, most profitable, technology companies are building enormous data centers to store and process data, which feed the Large Language Models (LLM) that AI tools are built on. This massive spending is driving economic activity through new construction projects and the enormous amounts of energy needed to sustain the data centers. The pace of spending is very reminiscent of the telecom buildout, which presaged the dot.com bubble. There are a couple key differences with this new revolution. Importantly, the spending on AI is being undertaken by large, profitable technology companies, which is quite different than the debt fueled spending by unprofitable start-up companies in the dot.com bubble. However, the expense numbers are so large that they are putting a huge dent in the free cash flow these large companies had previously enjoyed and now they are resorting to speculative forms of financing to keep up the pace of investment. Nobody is seeing an immediate return on their investments, but they are all optimistic that the productivity gains from advancements in AI will lead to future profitability. Having lived and managed through the dot.com bubble, I view this optimism with a healthy dose of skepticism.
I use AI tools every day and I can see the benefit already. It is going to allow corporations to operate with fewer employees and to spend less time on mundane tasks. It is going to bring structure and order to decision making and reduce human error. This is all good stuff that should make us all more productive. What remains to be seen is if all this investment will lead to higher profits, let alone gains that are high enough to justify current investments. The hyperscaler companies (Microsoft, Amazon, Alphabet, Meta, Oracle) are projecting that their AI capex spending will increase annually until it reaches over $500 billion per year by 2029. As this spending eats into their profits, they eventually will have to cut back. Then it will be time to see if this was all worth it and history will be the judge. My primary hesitancy in accepting the most optimistic story line is that there appears to be a substantial amount of competition among the hyperscalers that process the data. There is a crowded field of companies that all produce the LLMs and much of it isn’t even proprietary (open-source code). There is also significant competition for the entire ecosystem from foreign entities in China, India and Europe. All of this attention should lead to amazing advancement, but it could also lead to less impressive future profitability for the early leaders. I don’t think they will achieve the monopoly status that the dot.com and social media empires realized from the last technology revolution. Those companies benefited from the “network effect,” where being the first dominant platform (ex. Facebook) made it unattractive to use any other platform, since everyone in your network were all using the one dominant platform. Switching between LLM competitors like ChatGPT, Microsoft CoPilot, Perplexity, Gemini (Google), Grok (Elon Musk), Claude (UK/Athropic), Llama (Meta), DeepSeek (China), Mistral (France) and countless others is basically frictionless. Also, none of them are significantly better or worse than the others. As such, we have been reluctant to embrace the sky-high valuations being paid for AI stocks.
We are underweight stocks as an asset class and underweight US stocks in particular. Small US corporations have been trending strongly higher on hopes that the US can avoid a recession and that the Fed will continue to lower interest rates to combat a slowing economy. We remain concerned about the strength of the economy and have therefore avoided this space, despite the recent rally. International and Emerging Market stocks have been significant outperformers this year. This is partly due to a declining US dollar, which gives US investors a boost when we convert foreign earnings into weaker US dollars. Another reason for the outperformance is that valuations remain historically cheap versus US stocks. Valuations are attractive and we continue to favor these holdings. We are still concerned about the Chinese economy, so despite recent strength in the Chinese stock market, we are holding positions that specifically underweight Chinese stocks in the portfolio. Our allocation to Gold has paid off nicely so far this year. The thesis for the position is grounded in our concerns about the valuation of the US dollar, considering high national debt levels and our inability to address fiscal imbalances in a prudent manner. The rise in Gold prices has been swift, with over 32% per year annualized returns for the last three years. However, we believe conditions are still uniquely supportive.
As always, please feel free to reach out with any questions. In the spirit of the upcoming Thanksgiving holiday, I will close with saying “Thank You” for your business and the trust you place in our firm.
Cordially,
Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®
The views and opinions presented in this article are those of Shane Alsworth only
Sources: Morningstar/Ibbotson data, BCA Research, Litman-Gregory Advisor Intelligence, iMGP
*US large stocks (S&P 500 Index), US large cap growth (Russell 1000 Growth Index), US large cap value (Russell 1000 Value Index), US small stocks (Russell 2000 Index), (Developed international stocks (MSCI EAFE Index), Emerging Market stocks (MSCI EAFE EM Index), Core investment-grade bonds (Bloomberg U.S. Aggregate Bond Index), Floating Rate Loans (S&P/LSTA Performing Loan Index), US Dollar (DXY Index), Gold (Aberdeen Physical Gold ETF), Commodities (Bloomberg Commodity Index)
