Global equities extended their advance in the third quarter, with major indices — including the S&P 500, Nasdaq and our local ASX — reaching new record highs. Investors appeared largely indifferent to ongoing geopolitical tensions and a slowing US economy. The rally represents a continuation of the upward momentum seen through much of 2025, aside from April’s brief but sharp correction and swift rebound.
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Momentum in global equities strengthened following the US Federal Reserve’s decision in September to reduce the federal funds rate by 25 basis points and signal a gradual series of cuts for the remainder of the year. Chair Jerome Powell cited mounting evidence of labour market weakness as justification for easing policy after maintaining rates since December, when inflation risks linked to tariffs had kept the Fed cautious.
The Federal Reserve now faces a delicate balancing act between competing economic forces. Growth has effectively stalled, tariffs are pushing up costs and disrupting supply chains, and job creation remains sluggish — partly due to reduced migrant labour under tighter border policies. Slower growth, rising prices and a weakening labour market together raise the spectre of stagflation, a troubling prospect for both the US and the broader global economy.
Artificial intelligence remains a dominant market theme, with technology leaders such as Nvidia, Meta Platforms, Microsoft, and Alphabet continuing to outperform. Even traditionally slower-moving companies, including Oracle and Intel, have benefited from renewed investor enthusiasm. Nevertheless, concerns over stretched valuations, aggressive capital expenditure, and speculative excess are becoming increasingly prevalent.
In China, equities have staged a strong recovery, with the Shanghai Composite up approximately 20% for the quarter and 36% over the past year (in AUD). The rally has driven the index to its highest level in a decade, fuelled largely by surging retail participation. Authorities have begun exploring measures to temper exuberance — including easing short-selling restrictions and tightening oversight of speculative trading activity.
Despite multiple warning signs, investor sentiment remains buoyant. As John Maynard Keynes famously observed, “The market can stay irrational longer than you can stay solvent.” That maxim appears fitting — markets continue to look past deteriorating fundamentals, pricing in optimism that may prove difficult to sustain.
The local share market has continued its upward trajectory since the initial announcement and subsequent pause on tariffs. However, the overall gains cover up some turbulence in individual company stocks. Large “blue chip” companies like CSL and Woolworths experienced sharp falls when their earnings guidance fell short and may indicate increasing anxiety around market valuations.
The rally of global share markets since April gained further momentum in August after the US Federal Reserve indicated it would cut interest rates at the September meeting of the FOMC. The post-meeting statement acknowledged slower job gains, a slight uptick in unemployment, and rising downside risks to employment.
10-year government bond yields in Australia and the US have been edging downwards since the start of the 2025. In the US a slowing economy and weak labour market implies the Federal Reserve will continue its rate cutting cycle, which is boosting the returns of the global bond index (hedged into AUD).
August CPI data was higher than expected, forcing the RBA to pause their rate cutting cycle. The un-employment rate held steady at 4.2% despite slowing employment growth and falling job vacancies. The inflation Rate in Australia is expected to be 2.9% by the end of this quarter, according to analysts’ expectations.
The Australian economy grew 0.6% quarter on quarter in Q2 2025. It was the 15th straight quarter of rise, driven by domestic demand, due to higher spending on discretionary and essential goods. Looking to Q3, the GDP Growth Rate in Australia is expected to be 0.6%, according to analysts’ expectations.
In Australia, weak employment data initially increased expectations of a September rate cut, but these were promptly reversed following stronger August inflation figures. This increase reflected broad-based strength in underlying inflation, not just volatile items. Markets are now pricing in no more RBA rate cuts this year.
Gold is up over 45% for the previous 12 months, boosting commodity prices. Prices have been supported by global trade tensions, Federal Reserve rate cuts, and safe-haven demand amid geopolitical conflicts. Questions about US economic resilience, reflected by a weak US Dollar index and another Government shutdown, also added to sentiment.
Bond traders have slashed their expectations for further interest rate cuts in Australia after an un-expectedly strong August inflation number signalled to some in the market that the central bank could be done with lowering borrowing costs this cycle. Bond yields jumped after the consumer price index ticked up to 3 per cent in August. The yield curve is now flat out to 2 years.
The US yield curve has moved lower across all maturities over the previous 3 months. The short end is signalling confidence that interest rate easing will continue, while the longer term yields are reflecting the slowing of the economy. Consumer confidence has been falling on growing concerns about job prospects and the broader economy more generally.
In Australia, there was sharp sector rotation. Resources and energy outperformed, while healthcare and interest rate-sensitive stocks lagged. The local mining sector experienced a significant rally through July and August, boosted by optimism around Chinese demand. Australian small cap stocks have returned 15.3% in the quarter, 10% more than the ASX 300 index, and are on track for their best year since 2009.
Five sectors make up approximately 75% of the market, with the two largest constituting more than 50%. The bottom chart shows the 12-month performance of the five largest sectors.
The US Tech sector (Communication and IT stocks) are once again the main drivers of the overall US market. The continuing rally in stocks with greater growth potential is a headwind for more defensive sectors like Financials, Health Care and Consumer Staples, which have all been detractors to the performance of the S&P 500 index. Health Care stocks have been impacted by pharma tariffs, and their valuation discount to the market is the widest in 30 years.
Five sectors make up approximately 75% of the US market, with Tech companies constituting around 40%. The bottom chart shows the 12-month performance of the five largest sectors.
The Australian dollar finished just over $0.66 by the end of the quarter, remaining flat relative its price 3 months earlier. This is despite the fall in the US Dollar Index (which measures the USD against other major currencies) which has weakened on several US-driven uncertainties, including economic policy, debt sustainability and the US government shutdown.
The ASX Materials Sector is closely tied to the price of iron ore, which has been rising primarily due to improved sentiment in China's steel market and restocking by Chinese steel mills. Stronger-than-expected economic data from China and a pullback in steel output have also supported prices, while trade actions have had mixed impact.
This article was written by Dr Steve Garth - Principal of Principia Investment Consultants.
Disclaimer: Although information is derived from sources considered and believed to be reliable and accurate, Principia and its employees are not liable for any opinion expressed or for any error or omission that may have occurred in this presentation. This presentation is of a general nature only and has been prepared without considering any person’s particular investment objectives, financial situation, or particular needs.