A Rising Tide: Third Quarter Market Review and Outlook
Continued strong demand for artificial intelligence (AI) and massive capital investments have been a tailwind for earnings in the tech sector and beyond.
Key Q3 Takeaways
The broad U.S. stock market climbed to new highs fueled by strong corporate earnings, especially among technology companies.
Broad-based gains pushed all sectors of the S&P 500 index into positive territory for the year-to-date period.
The bond market rallied as well, buoyed by a dip in interest rates across maturities.
The U.S. economy continued to show resilience despite lingering inflation and trade uncertainty.
While the job market is weakening, unemployment remains low by historical standards.
For much of this year, uncertainty around trade, fiscal and monetary policy ran high. In the third quarter, however, investors got answers to some key policy questions with the passage of President Trump’s One Big Beautiful Bill Act and the Federal Reserve’s resumption of the rate-cutting cycle it paused nearly a year ago.
Investors also got welcome news on corporate earnings, which helped ease (but not erase) worries about the impact of historically high tariffs. The S&P 500 index posted strong earnings growth, beating analysts’ expectations by a healthy margin[AR1] . The index marked its nineth consecutive quarter of positive earnings.
Earnings growth, greater policy clarity and other tailwinds drove U.S. stocks to new highs. The third quarter marked the first time this year that the U.S. stock market outperformed international equities markets. Internationals, we should note, had been buoyed by a sharp decline in the value of the dollar.
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. *
The AI Effect
The technology sector, which tumbled in the first quarter has rallied after reporting Q3 strong earnings. The sector’s robust earnings growth accounted for nearly 60% of the S&P 500’s total earnings growth.
Continued strong demand for artificial intelligence (AI) and massive capital investments have been a tailwind for earnings in the tech sector and beyond. Some of the biggest names in tech and communications services are collectively planning to spend hundreds of billions to build and expand their AI infrastructure over the coming year.
Behind technology and communications services, industrials have been the third best-performing sector for the year, and that’s no coincidence. Massive investments in data centers, fiber-optic networks, and AI-related infrastructure have begun to flow through to the sector and lift earnings, helping to offset the pain of higher materials prices, labor shortages and other headwinds.
All in all, every sector fared relatively well for the quarter. Even consumer discretionary and healthcare, which were in negative territory at the end of the second quarter, saw positive returns.
Economic Resilience and The Labor Market
As reflected in the equities market, the U.S. economy has remained resilient in 2025 despite policy uncertainty, sticky inflation, and other headwinds. Gross domestic product (GDP) is expected to grow by 3.8%, according to the Atlanta Fed’s latest GDPNow forecast.
That said, the all-important job market has been showing signs of strain. Job growth has trended downward in recent months, and small business hiring continues to slow. The unemployment rate (still low by historical standards) ticked up to 4.3% in August.
Why is job growth slowing even as the economy continues to grow? Possible factors contributing to the slowdown may include; more-restrictive federal immigration policy, which is shrinking the labor pool, cuts to the federal workforce, and AI-driven productivity gains.
Either way, the weakening job market prompted the Fed to resume its rate-cutting cycle in September, after pausing for nearly a year because of sticky inflation and the potential inflationary effects of higher tariffs. The central bank cut its benchmark rate by a quarter of a percentage point last month and is expected to lower it by another half point by the end of the year, assuming the labor market does not show signs of improvement.
We are keeping an eye on the condition of labor market, which some have described as “low hire, low fire.” While layoffs have risen over the last several years, we haven’t seen the kind of spike that historically ushers in a recession.
Tax Cuts and Other Tailwinds
Our view is that continued investment in AI will help to bolster economic growth. By one estimate, between $3 trillion and $4 trillion will be spent on AI infrastructure by the end of decade.
We have yet to see the full economic impact of the One Big Beautiful Bill Act (OBBBA), which includes some complex and potentially controversial elements, such as its impact on the deficit and government spending. The bill also contains a range of incentives designed to support U.S. businesses, including tax provisions aimed at encouraging companies to build new factories and increase spending on heavy equipment.
Of course, the path forward won’t be without challenges. Trade uncertainty continues to loom large, including on-again, off-again skirmishes over tariffs between United States and China. What’s more, the U.S. is once again in the midst of a government shutdown, which can have wide ranging implications for the economy and the markets.
Staying disciplined and focused on long-term goals, we believe, remains the best approach for weathering market fluctuations. Periods of uncertainty often give way to opportunity.
*Note: views are from a U.S. dollar perspective. Data labels represent total year-to-date returns. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. Source: Kestra Investment Management with data from FactSet. Index proxies: Bloomberg U.S. AGG Bond Index, ICE BofA U.S. Corporate, ICE BofA U.S. High Yield, Bloomberg Municipal Bond, S&P 500, MSCI EM, MSCI World ex US Index, Dow Jones U.S. Select REIT, and Bloomberg Commodity Index. Data as of September 30, 2025.