Market Commentary | Q3 2025 Halftime Report
Summary
Welcome to Penobscot Financial Advisors’ Third Quarter Halftime Report. Join Sam Chaplin and Chief Investment Officer James Bradley as they explore where the economy stands heading into fall 2025.
In this update, we discuss:
- How recession risk indicators are shaping the outlook
- Inflation, employment, and the Federal Reserve’s balancing act
- The impact of trade tariffs and shifting global dynamics
- Why international markets are outpacing U.S. equities this year
- The role of AI investment in sustaining growth
- Who really holds influence over market direction
Transcription
[Sam Chaplain]
Hi everybody, welcome to PFA’s Halftime Report. We’re here for the third quarter. Hope everybody’s had a great summer, has been enjoying the nice weather lately as we turn into fall.
I’m joined today by our president and founder, Jim Bradley. How are you, Jim?
[Jim Bradley]
I’m doing great, Sam, and truly enjoying the weather. I guess we do need a little rain, so, you know, we’ll take it probably back on weekends by the…
[Sam Chaplain]
I was saying that ironically at the beginning of the year, but now we actually need it. That’s right. Great, so as always, we’re going to give you a little insight into what we’re seeing in the economy, seeing in markets, things we’re looking at going forward, and I think Jim’s going to kick us off.
[Jim Bradley]
Let me do it with something that we’ve kicked off the past few with. Sam and I have been treating you to a little bit of a look under the hood at what we’re seeing when we consider recession risk, which is always something that’s kind of front of mind for us and for our clients right now. We’re not looking…
we don’t have the end of August data quite yet. It’s just being a couple days since the end of August, but we’ve got end of July data, and, you know, short answer to what we’re seeing is not very big changes to what we’ve been seeing over the past few months, really since the beginning of the year. Out of the 12 major indicators that we track, nine of them are still flashing expansion.
Only two of them are flashing recession, and that’s a pretty comfortable place for us. We’d sure love it if everything was flashing expansion, but that’s rarely the case. New orders from purchasing managers are showing a little bit of slowness as well as job sentiment, and I think that a lot of that’s really to be expected in a world where we’re pretty uncertain as to where trade tariffs and costs are going to end up and what that’s going to do the economy as a whole, but everything else seems to be kind of holding in.
I’m adding a second slide to kind of look at that going back by comparison to the last one, two, three, four, five, six recessionary periods that we’ve actually seen, and this is a really actually comforting thing to look at because during those prior recessions, those indicators almost always are right in line with what we’d expect to see going into a recession. They’re mostly all flashing red, and in some cases, in a couple of them, there were all 12 of them flashing red. To see right now still two-thirds of them flashing green and only a couple of them flashing red feels decent to us.
Obviously, we always want to approach this with some caution, but with the exception of what we saw in 2020, which was pretty sudden, we’ve got usually a little bit of a clue that things are turning in that direction. Right now, we’re not seeing a lot of progress in that direction. We’re always going to be interested in taking a look at what we’ve always kind of considered the dual mandate of the Fed, which is to consider jobs and prices.
Prices tend to look like they’re kind of bottoming out a little bit in their trajectory downward, coming up at most recent movement in the core PCE price index of just under 3%, which is still a little bit hotter than what the Fed is looking for at 2%, with the unemployment rate kind of wobbling around at about 4.2%. You got to really look under the hood a little bit further to get, are there things that are coming down the pike that could start to move these numbers? We’ll talk a little bit more about the Fed, but I think that as long as we’re still conceivably heading more toward that 2% target than straight up on inflation, the more that we see ourselves shying away from that 5% level of unemployment that the Fed tries to stay away from, those are things that I think we’re going to see the Fed leaving with an idea that they don’t have to be making any big sudden moves on the monetary side to really fix anything, because there’s not really a whole lot to fix, comma, yet. It’s a matter of what’s coming down the pike.
Sam’s going to start in with talking a little bit about one of the things that could be starting to jostle our future expectations here.
[Sam Chaplain]
Yeah, thanks, Jim. I think it’s starting to really get interesting for the Fed here. They’re the easy part now of, all right, we got inflation, we’re going to hike crates into restrictive territory, and we’re going to keep them there until inflation’s gone, provided unemployment doesn’t spike and we cause a recession and that type of thing.
We’re at that point now where inflation’s kind of bottomed out a little higher than they would have liked it to be, but unemployment is on the up. Two real problems they’re going to have to contend with that is we got uncertainty on both prices and on jobs. On the prices side, we’re looking at tariffs.
As everybody, I’m sure, is aware, a new trade war has been launched by the Trump administration, crazy numbers flying around, changing day to day on what’s being tariffed, what’s not being tariffed. This is really hard to kind of put into your economic models when it changes by tweet every few minutes. So from that side of things, really difficult for the Fed to understand what inflation is going to do in the future.
And I think if we learned anything throughout COVID, it was how little we actually know about inflation. So the idea that, is this going to be transitory? Is this going to be a long and variable lag?
Is this going to be a one-time increase to prices when it flows through, or is this going to be sustainable, a cycle of higher prices over time? Unfortunately, so far, I think the 90-day pause on tariffs allowed a lot of companies to front run the tariffs, build up their inventory before they went into effect, and now they can sell off that inventory, which still has relatively low costs. The longer this goes on, they’re going to have to start buying at those higher costs, potentially passing them on to consumers in the form of higher prices.
So that’s a big riff at the Federal Reserve right now between the different members. Some think this is a one-time price increase. Some people think this could lead to a resurgence of inflation.
So we’re seeing some disagreement there. So that’s the concern and what’s clouding the price side of things and the inflation side of things. And then on the other side, the other mandate they have is to keep unemployment low.
And we’ve seen these massive job revisions over the last several months as well. So that’s making their decision more difficult. We got these kind of blockbuster job reports that were looking really good.
And then a couple of months later, the Bureau of Labor Statistics said, hold up, hold up. Those actually weren’t as good a numbers. We got to revise them.
And just to give you some examples here, the May report was originally 144,000 jobs added. That was revised down to 19,000. June’s gain was 147,000 jobs added.
That was revised down to 14,000. So big differences in those numbers. What wasn’t really a labor market concern for the Fed all of a sudden became one a lot quicker.
Some of the reasons gets really politicized, but the BLS sends out surveys that haven’t been getting its higher response rates, less quality answers going on in there. So that is a valid concern and open to how we’re going to correct that. I mean, I think what’s most important here is that we maintain the integrity of this data, however that is.
But when you’re getting bad inputs, you’re getting the garbage in, garbage out type of forecast. And that’s what the Fed’s been contending with lately. So I think that’s shown through in the Jackson Hole meeting at the end of last month, which I think Jim’s going to touch on.
[Jim Bradley]
We were all sitting there at nine o’clock in the morning eating popcorn and watching Jerome Powell at the Jackson Hole meeting, delivering his speech. And for those of you who are anticipating that Chair Powell is going to come out and give us really firm guidance on what they’re going to do at the next Fed meeting with any of his speeches, you’re always going to be disappointed because they never do that. However, this was one situation where clearly the rhetoric that Jerome was putting out there really led the markets to actually have a little bit more certainty on what’s likely to be the outcome of the next Fed meeting.
And we can see that with the orange line here jumping up basically in real time as he delivered his speech at Jackson Hole, really focused a lot more on his concern about what he’s seeing in the job market, whether that’s short term, like I say, displacement as a result of deportations and that type of thing, or whether it’s because of a more kind of long term trend toward a slowing economy and slower job market. He pretty clearly, if you count the amount of time he spent talking about that versus concerns about inflation going up, which he also dismissed potentially as something that he didn’t want to use the T word like transitory because that hasn’t worked out well in the past, but maybe more like one time type of price event seemed a lot more focused on the jobs concerns, which really led the market to essentially price in close to a 100% probability of a rate cut in September. So we’ll still watch this closely.
We’ve got additional job reports coming between now and that Fed meeting, and we’ve got additional inflation data coming between now and that meeting. So to the degree that that probability moves off of 100% because of anything that we see there, that’s likely to move markets as well. Strap in, I would say for the remainder of quarter three here, it could be a little bit of a bumpy one.
So far, equity performance has been relatively okay with the exception of a relatively sizable divot that we saw after April 2nd’s quote unquote liberation day tariffs announcement. We’ve kind of clawed that back. We’ve certainly clawed back all the space that we lost.
When we look at international markets, this graph shows us both international and domestic markets with international being the darker blue color and domestic U.S. markets being in the attractive teal color. You’re seeing a pretty significant outperformance so far year to date by non-U.S. markets relative to U.S. markets. A couple of potential reasons for that, well, one’s potential and one’s just the way things work.
One potential reason is that the U.S. markets were already priced at multiples of earnings that are higher than what we’d kind of consider normal, whereas international markets, especially in Europe, were priced at relatively low levels relative to historical norms. So they didn’t have quite as much of a headwind to go against when it came to valuations. Then in addition to that, the thing that really is reliable is a weakening dollar.
Whenever we see a weakening dollar, that’s going to be a tailwind to international stock performance. So far, diversification internationally in 2025 has been a very helpful thing for portfolios and one of the things that most people who have been involved in allocating internationally have been really pleased with how it’s actually helped their portfolio performance. On the bond side, that hasn’t hurt us either.
We’re looking at a couple of tumultuous years in the past couple of years, especially 2022, where interest rates spiked up, driving bond prices down. But now bonds are back to doing their job again, which is adding diversification while providing some degree of returns for us. Here, on the other hand, US is outperforming international.
I think there’s a little bit of depth of market that’s to be given credit for there. But in both cases, they’re both trending upward and to the right at a relatively stable pace, which is what we look for bonds to do. Back over to you, Sam, with some interesting input on what’s actually driving all of this.
[Sam Chaplain]
Yeah, thanks. I’d like to wrap this up every quarter with a little frequently asked question. This one actually comes from my mother, so shout out to mom.
But the question is basically, given all this uncertainty surrounding inflation, trade policy, we got multiple wars going on, all this, why is the market doing so well? And I think it’s a really reasonable question. And I got two slides here that will hopefully help explain some of that.
The first one, and both of these are going to surround who’s driving this thing, who’s driving the market. First one’s going to be surrounded here based on who owns the market. So it’s going to tell you based on the wealth distribution on the left side, how much of the US equity corporate ownership do they own?
So you could say the top 1% owns almost 50% of equities in the US. Conversely, down at the bottom 50% own only 5.6% of the equity. So that’s a pretty shocking figure that, I don’t know, feels illegal to know that for some reason or something like that.
But if you think about what policies, what type of direction is good for that top 1% versus that bottom 50%, the top 1% is not going to be as worried about social security reform or immigration reform, all that type of stuff. They’re going to be more looking at things like tax cuts, deregulation of businesses, stuff that really is aligned with their incentives. And they are the ones who own most of the market.
Conversely, the bottom 50% might not be happy with the way things are going for them, but they don’t have a whole lot of vote in the market at this time, unfortunately. So that’s a big part of it. You got to consider who owns the market and kind of divorce yourself from the idea that the market represents any type of social index or anything like that.
It is not an average of how the average American doing. It is, here’s the breakdown of who’s voting on this thing. So that is important to know.
Another one is these headline numbers have been great, but some of the slowing in the economy, right? We’ve seen, you look around, you’re probably seeing more homes for sale, a lot of those type of recession indicators, businesses closing. And how is that happening?
And how is this headline number staying so good as far as GDP growth and business investment and all that? And this is going to show you here that a lot of the AI investment has been really compensating for a lot of the drop down in consumption that we’ve seen. So consumption, buying goods and services that people do typically makes up almost two thirds of the U.S. economy of GDP. And we’ve seen that number coming down. But as we have, we’ve seen all this AI related investment really popping up. So that has helped kind of smooth some of these numbers, even though, again, things might not be going as well for the average American, that’s not showing up in the headlines and that’s not showing up in the markets because are really these two factors.
Who’s driving this thing is the wealthier owners of the market, wealthier people, Americans, into that a lot of this AI investment is really kind of softening the blow of the fall in consumption. So those are two things that we want to leave you with. And, you know, again, I think the goal objective I’m getting to here is we shouldn’t like look at, you know, forecast the social elements of the future and then translate into that markets because that’s really not the purpose of markets.
And yeah, I think that’s where we’ll leave it today. So thanks again for joining us and we’ll see you next quarter. See you next quarter.
Looking forward to it.
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