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The third quarter of 2025 saw the continuing surge of the Artificial Intelligence (AI) economy as AI capex and the associated knock-on effects buoyed earnings and stock prices broadly during the period. This was in no way limited to “the Magnificent 7” (Microsoft, Amazon, Apple, Meta, Alphabet, Nvidia, and Tesla) at the heart of AI’s transformations, as utilities, data centers, and some areas within software got a strong lift. Small caps also had a robust quarter as earnings seem to have bottomed. Against the backdrop of the Federal Reserve (the Fed) cutting interest rates by 25 basis points in September, hopes for continued equity market strength were sustained and some fixed-income segments were able to deliver modestly positive returns.
Key areas of focus include:
- A broadening market: As mentioned last quarter, FEG believes investors would do well to consider pockets of opportunity outside of U.S. large cap stocks, including small caps and non-U.S. markets. Combining passive U.S. large cap exposure with differentiated strategies that focus on less efficient areas of the market is one way to capture general market upside potential with more idiosyncratic opportunities that can support income and growth objectives when markets move in a less linear fashion.
- Cost of capital: It is important to watch the Fed, but the need for scrutiny is particularly strong today given the economic and political pressures that might move the dial on the Fed’s decision-making. At the moment, the market is pricing in two additional rate cuts for the remainder of 2025. If policymakers continue to cut, investors need to consider the prospects for asset class winners and losers. We believe a cutting cycle should generally support risk assets since it would lower the cost of capital, giving further momentum to the bull market in equities, despite rich valuations in U.S. large cap stocks.
- Manager access: Many investors’ allocations to alternatives are at or above their long-term targets, due to a continued lack of distributions from private investments. FEG believes this presents an opportunity to gain exposure to managers who historically have been difficult to access.
Although corporate spending and venture capital funding for AI has soared, that will not always make AI an ironclad investment thesis or necessarily generate an attractive return on investment. The trend, however, shows no signs of slowing down. New, innovative use cases and companies will continue to be born out of this cycle, but there will also be misallocation of capital and poor subsequent returns for some companies and use cases. As investors, we must do our best to figure out the difference and position portfolios accordingly.
Read the full Q3 2025 Portfolio Insights.