Economic & Investment Outlook: Two Speed Economy

By: Brian Seay, CFA

There are a lot of questions on the minds of investors. Usually after a big market gains like we experienced over the summer, everyone is happy and thinks things are going great. But I hear a lot of concerns from folks on a regular basis this time around.

I think that’s warranted because we are living in a world with two different economies running simultaneously. One is in a recession. The other is partying like it’s 1999. How we invest wisely based on what’s really happening is going to be very important over the next few months and into 2026. In this outlook, we’re going to talk about the gains we have seen so far this year and whether we are in a market bubble. I’m also going to help you resolve the difference between your feelings about the economy and what you are seeing in your portfolio – because what you feel may not be what you’re experiencing in your investments.

As always, I will share my views on the stock market, interest rates, the Fed, inflation, real estate and other assets like Gold.

Transcript:

Hello and welcome to Q4 outlook on the economy and investment markets. If we haven’t met, my name is Brian Seay, and I’m glad you’re joining us. There are a lot of questions on the minds of investors. Usually after a big market gains like we experienced over the summer, everyone is happy and thinks things are going great. But I hear a lot of concerns from folks on a regular basis this time around. I think that’s warranted because we are living in a world with two different economies running simultaneously. One is in a recession. The other is partying like it’s 1999. How we invest wisely based on what’s really happening is going to be very important over the next few months and into 2026.

In this outlook, we’re going to talk about the gains we have seen so far this year and whether we are in a market bubble. I’m also going to help you resolve the difference between your feelings about the economy and what you are seeing in your portfolio – because what you feel may not be what you’re experiencing in your investments. As always, I will share my views on the stock market, interest rates, the Fed, inflation, real estate and other assets like Gold – which is now up over 40% for the year.

As always in these outlook episodes, there are lots of charts and visuals, so consider watching the recording on YouTube if you’re listening via the podcast feel. Alright – let’s dive into the economy and markets as we close out 2025.  

Let’s start with what’s happened so far this year. On the chart you can see that gold remains the top asset class for the year, up more than 45%. You probably know your stock portfolio is up as well – the big tech names in the U.S. get all of the media attention. However, international stocks have outperformed the U.S. across the board so far this year, up in the mid 20% range depending on the country you look at. The S&P 500 is no slouch up 14% and even stodgy old bonds have returned more than 6% so far this year. This is why diversification is so important and why its key to go beyond owning just tech stocks or the even the U.S. stock market index in a long-term portfolio. US returns have been good, but a broad mix of assets has seen better performance with much lower levels of concentration risk and volatility.

So it’s been a good year so far for investment markets.  However, it’s important not to get lost in short-term thinking when you have long-term investment goals. The next chart shows long-term historical average returns for the various asset classes. Returns from last 29 years are likely much more in-line with your long-term investment goals that what’s happening in any one market year. The S&P 500 remains the best performing long-term asset class, with returns annualizing 10.1% each year. Gold, after a decade of almost no returns, has had a big run the last few years and is growing 8% annually. Bonds are up 4% each year, and despite all the headlines around inflation, inflation is up 2.5% on an annualized basis over the last few decades.

When we zoom in and look at the past decade, The S&P 500 has returned more than 15% each year on average, Gold is now averaging more than 12%, and Bonds are actually the laggard averaging only 1.8%.

So as we talk about our outlook for the economy, geopolitical events, politics and markets, keep in mind that we had all kinds of major events over the past few decades. You would be a very happy investor today if you invested at the peak of markets before the global financial crisis, right before Covid, or right before any number of bad news cycles over the last few decades. Managing risk and diversification is very important but so is making sure that your starting point is a portfolio than will accomplish you long-term goals. You should be able to stick with it over time. If you are concern about the impact of a stock market bubble on your financial future – that’s probably a sign that you need to review your situation. Think about your investment portfolio and other assets - and whether you feel comfortable regardless of the environment – good or bad - going forward. If you have concerns, then it’s probably time to seek out professional advice.

So now that we have level set about the investment environment, lets shift gears and talk about where the economy sits now and where I see it headed for the rest of the year. Once we have a good feel for the economic environment, then we will move to a discussion of specific investment assets like stocks, bonds and real estate and how they may perform given our situation.

I want to spend a few minutes on what I see as two different economies that exist today. Let’s start by getting our feelings out – I know hard for many of us to do – but lets start there and then look at some data and walk though why reality doesn’t match our feelings.

The chart shows U.S. Consumer Sentiment – which is a survey done by the economics department at the University of Michigan. The ask regular consumers questions like are you financially better off this year vs. last year, what is your perception of inflation, is now a good time to make big purchases etc. The results create this index. I won’t go deep into the statistics, but “Good” is generally in the high 80s or low 90s, which we last saw before Covid. Anything below 70 is generally bad and considered recessionary. We’ve been having out in the 50s and 60s and getting worse. So consumers don’t feel like they are better off than last year. They aren’t optimistic about the economy.

Yet the S&P 500 is up 14% and GDP is positive – so let’s talk about GDP for a minute.

Real GDP is how we measure whether the economy is growing larger or contracting smaller. Headline real GDP in the first and second quarter of the year was running at 3.8%. The economy is in-fact growing, however tariffs have significantly altered import and export activity this year. Businesses imported more in Q1 to front-run tariffs, and they imported far less in Q2 after the tariffs began to take effect. Remember Imports detract from GDP - So Q1 GDP is lower than it would have otherwise been and Q2 is higher than it would have been. What we like to do is cut through all the noise and look at something called domestic final sales, which is the combination of consumer and business activity in the U.S. That number was a positive 2.9%. No matter how you look at it, the economy is growing even after adjusting for inflation. So if the economy is growing and the market is up, why all the bad sentiment?

The issue is that the growth is very concentrated. 100% of the increase in GDP has come from the AI boom – either directly from tech or areas that are indirectly linked to the firms building out AI data centers. That accounts for about 8% of the total economy. So 8% of business and 8% of workers are seeing extremely high levels of growth. The remaining 92% of the economy is flat.

We also see concentration in household spending – which drives the headline retail sales numbers that get reported out. The top 10% of households account for just over 49% of consumer spending. Those households have assets that have been increasing as stocks and other assets have risen in value, so they are having no trouble spending. In august, the top 10% of households grew spending at 3.3% according to Bank of America. Inflation is running at about 2.9%. While the top 10% actually grew their spending in real terms, even the next decile of earners the group between the 80th and 90th percentile – only grew their spending at 2.8% in August, meaning they weren’t keeping up with inflation. So, most households aren’t spending more than last year, they are simply paying higher prices for the same goods and services.  Like economic growth, spending growth is very concentrated in a small number of folks. If you’re wondering, the top decile of income earning households that are doing so well in the U.S. make about $250,000 each year.

Let’s talk about the labor market. Same concentration issue. First, can we talk about data quality for a minute since it seems like we have all awakened to the fact that government data is revised. A couple of points. First, revisions to government data are not new. This has been happening since the beginning of the surveys. As more data comes in, the BLS revises their number. In fact, we actually learn a lot from the revisions, historically, large revisions meant that the economy was at an inflection point. Large positive revisions mean the labor market is really improving and large negative revisions tell us the labor market is really getting worse. So economist and market watchers project revisions and take all of this into account when we think about the economic situation, we aren’t easily fooled by headline numbers. Second, private organizations have tried to recreate the BLS surveys on employment and otherwise. Their versions are less accurate than the government numbers. Why is that? That’s because organizations are legally required to respond to the government. They are not legally required to respond to a random economics shop trying to collect data. So while they may be delayed in their responses, ultimately all businesses respond to the government. Now, could the BLS use other data outside the employer and household surveys to inform their labor market data? They could. Might a statistician at the BLS have thought that lower initial response rates were a problem? In fact, they’ve been requesting money to modernize the surveys for years. Instead congress cuts their budget. It takes investment to build new surveys or link data from other departments. Perhaps long-term other methods are more efficient, but they require capital upfront to implement. No different than in a business. Last point I’ll make on government employment data is that it seems like its easy to just use, for example, tax data or payroll tax data to calculate unemployment. The problem is that each data set has its own issues. Survey data has lower response rates. Tax data doesn’t include business owners and 1099 employees that don’t pay their payroll taxes on a bi-weekly basis. So there is no perfect data set, but what we have is useful for us to understand what’s happening in the economy.

Alright – I’ll get off my soapbox for this episode. Let’s talk about what that government data says about the labor market. The short story is that its getting weaker. Additions to Non-farm payrolls are averaging 29,000 over the past 3 months. I do believe that we should be creating fewer jobs than a couple of years ago, but breakeven job creation in the U.S. is still likely more like 70 to 100,000 each month, indeed the 3 month average of additions to the labor force is 89,000. So 29,000 jobs a month is not going to cut it. You can see in the chart on the right we’ve dropped below the big black line on my “Are we creating enough jobs chart.” We can stay below the line for a month or two, but if we stay this low for any length of time, the unemployment rate will start to rise and that eventually turns into a recession.

Outside the nonfarm payroll data, you can see in the chart that the number of job openings has continued to decline over time and the number of unemployed workers now finally exceeds the number of job openings for the first time since the covid reopening. Also, average hours worked are down to almost recession levels for folks that do have a job. Companies aren’t laying off workers, but they are keeping hours as low as possible. Lastly, wages are actually growing at a healthy clip year over year – but again – this is concentrated in AI, healthcare and technology.

When we put the picture together we see the majority of companies in the U.S. see their business activity flatlining – not negative – but simply stalling out. The majority of workers and consumers are struggling to deal with higher inflation. But a few AI focused companies and very high end consumers are carrying the total economic statistics higher. In fact, without the AI boom, we would be in a recession right now. The difference is that stark.

Lastly, lets talk quickly about inflation before we move on to investment markets. Core PCE – the Personal Consumption Expenditure Deflator – is my and the Fed preferred gage of inflation in the real economy. Core PCE is running about 2.9% currently, up from a low of 2.6% earlier in the year. Tariffs are contributing about 0.4% to inflation currently, so they essentially make up all of the increase we have seen thus far in the second quarter. Without the price impact of tariffs, we would likely have seen the economy hit the Feds 2% target by year end. Instead, the market is now expecting inflation to be between 3 and 3.2% around year end as more tariffs come online. It is true that U.S. companies have been eating the cost of tariffs thus far. That’s been possible because tariffs have been on and off during negotiations, allowing companies to send their shipments when tariffs did not apply. We have heard from numerous companies, include major discount retailers like Wal-Mart and Target that tariffs will have an increasing impact on pricing as the year progresses. Tariffs continue to roll on and off, so my best guess is that we will see inflation move into the low 3% range and stay there perhaps for the 1st half of next year, before eventually beginning to fall back to 2%. This will be a slower burn of price increases vs. an “all at once” approach. My view on this hasn’t changed much since the summer, I expect tariffs have have about a 1% total impact on prices for a period of time.

So we have a concentrated economy – with very concentrated growth and lots of stagnation combined with higher inflation than we would like. That continues to set-up as the “stagflation lite” kind of environment that I described over the summer. So given this backdrop in the economy, how do we invest?

I will start with stocks and then talk about bonds, gold and real estate.

I start with stocks because equity exposure generally forms the bulk of portfolios aimed at long-term growth. When we think about portfolio construction, the major question is really how much stock exposure should we have? Equities, both public and private, provide the bulk of portfolio growth over the long-term. After that important question is answered, you can fill in the rest with diversifying assets.

When you turn on the news at night, the story has been all about U.S. large cap growth. But U.S. stocks are actually lagging behind their international peers so far this year. We’ve been focused on investing outside the U.S. since the beginning of the year and rightfully so.

Both developed markets like Europe and Japan and Emerging markets like China, Brazil and Eastern Europe. Yes, the Chinese stock market is up more than 40% for the year. Why the big outperformance in international markets and will it continue?

The biggest single driver of foreign asset outperformance is an own goal of sorts – and that’s the decline of the U.S. Dollar so far this year. The bulk of that decline, as you can see in the chart, occurred around “Liberation Day” in the spring and the dollar has been holding steady at lower levels since then. Regardless of your views on whether the U.S. should import more or less foreign goods, if we import less, there is less demand for dollars and so the dollar depreciates. On top of the mechanical issues associated with trade, investors have shifted assets from U.S. stocks into international stocks for the first time in a decade.

Let’s talk about emerging markets more specifically. First, I think its worth noting that this category probably needs a new name. Countries like China, India and Russia were thought to be undergoing structural reforms to look more like Western economies in the late 1990s. While their populations continue to “emerge” into higher per-capita incomes, I think its safe to say their economic structures aren’t going to turn into western capitalist societies. So we have to evaluate them based on what they are today – no different than any other country in the world. China has largely avoided a major bust from its real estate overhang thanks to significant government stimulus this year. That, in addition to stocks focused on AI, is largely the reason for the 40% run up in Chinese markets year to date. China is very reliant on exports, and while their reliance on the U.S. has declined over time, they still have lots of unused manufacturing capacity that is both keeping global prices low and causing their economy to be weaker than the CCP would like. So the road forward will be harder for investors after this year. India, Brazil and others are in better shape, assuming they can get their trade situations with the U.S. resolved.

Do I think the U.S. is losing its position as the main driver of global economic growth? No. I think the U.S. will continue to be the best place to be long-term. But can international assets outperform U.S. stocks when the U.S. has anemic growth, higher tariffs and higher stock valuations? Absolutely, and that’s what we have seen so far this year after surprise fiscal stimulus in Europe. The run up in developed international markets has corrected what was a discount to their long-term valuations, so the stocks aren’t on sale, but they aren’t overvalued like the U.S.

Let’s turn to the U.S. Stocks should (and do) track their earnings growth over the long-term. Companies make more money, stock prices go higher. Simple. We started the year with analyst’s expecting 14% earnings growth across the S&P 500. I mentioned in the 2025 Outlook, I thought that was an optimistic outlook, everything had to go right for earnings to grow that much. Obviously now with tariffs, everything is not going right. What’s funny is that earnings expectations have dropped down to about 9.1% for the year. You would think that would be bad news for the market, but on the contrary, the stock market is up. That means the multiple that we are paying for corporate earnings has increased.

I did an entire episode on market bubbles at the beginning of September, so you can see that for more discussion. But, despite the stock price run up, I don’t believe we are in a bubble.

Currently the S&P 500 trades at 22x next year’s earnings. The 10 year average is closer to 18x. The peak in the tech bubble was around 25 times earnings. 22 may sound close to 25, but to get to multiple of 25 times earnings, the market would need to rise above 7300 from 6800 today, that’s another 8% increase on top of what we have seen thus far. Additionally, the companies sporting high valuations are actually driving significant cash flow growth. This is very different than what we saw in the late 1990s. Microsoft is not Webvan. Nvidia’s net income has moved up from around $4B at the end of 2022 to now tracking at over $70B per year. That’s a massive increase in real profits generated by the company. Alphabet – better known to many as Google – has seen Net Income move from $75 Billion annually to north of $115 Billion. Meta – or Facebook – or even better Instagram – their Net Income has gone from about $40 Billion to $70 Billion annually. So, in my view, bubble territory would be even higher this time around because company valuations SHOULD be higher than they were in the 1990s. So on a PE basis, the market is certainly not cheap – which would be below 18x earnings – but its also not as expensive as it was in 2000. I’m cognizant of watching for a bubble, but I think it makes more sense to start to worry about bubble territory when the forward PE for the S&P 500 starts to move north of 25 times earnings.

You can see in the chart, the economic concentration is in AI – and the AI related Mag 7 stocks are leading the way from an investment standpoint. That’s why we start with the economy, so that we can understand where the investment opportunities lie. In the U.S., en tilting towards growth stocks and away from stocks that are more sensitive to the broader economy has worked well so far this year and this has been the case for several years as the economy is slowing down. Despite the economic stagnation, AI and tech are still able to growth their businesses. I think this is likely the case for the foreseeable future unless valuations really get stretched. Trying to time market peaks is impossible and risky. Instead of attempting to identify the top, rebalancing the gains into other parts of the equity markets like international stocks, or even other assets like Gold or Bonds is the best way generate long-term portfolio returns.

Outside of large-cap, the stocks of smaller companies have rallied recently on news about rate cuts. We have seen this movie before in the cycle. Small caps have been negatively correlated with interest rates for the last several years. You can see as rates go down, the Russell 2000 index moves up, then rates adjust back upward and the stock prices fall. That’s in stark contrast to Larger Cap stocks. The reason is that only about 63% of the small cap stock universe is profitable – and the index makes only 6x their interest expense on a quarterly basis. So lower rates really impact the profitability of the companies – actually far more than many other economic factors. Simply put, if the economy simply continues to grind at a sub 2% level, it will be difficult for small caps to break out of this cycle where they simply trade with interest rates. So my view is that there are better ways to capture long-term growth in a portfolio.

So with tepid growth and high stock valuations, my view continues to be that investors should have increasing exposure to assets outside of the stock market – and more so as its valuations increase. In the past, that has meant giving up returns, but not anymore.

Let’s start with bonds and interest rates.

Intermediate bonds are up more than 6% for the year so far – many of you have investment return goals that are in the 7 to 8% range – so a well-run bond portfolio can do a lot without the risk of a market downturn. The U.S. 10 year started the year north of 4.5% and is now sitting just over 4.1%. That means investors in both U.S. government bonds and corporate debt are earning both interest coupon payments and total returns as the value of their bond portfolios increase. Bond from emerging market countries have led the way up over 10%. Central banks around the world have cut rates – again – ahead of the Fed – which drives returns. We also see the dollar depreciating relative to foreign currencies, which means those interest payments in foreign currencies buy even more in U.S. dollars. High yield and investment grade corporate bonds have also outperformed.  You can see one money market fund on the chart, the brown line, up 3% for the year. Not bad for cash, but other forms of fixed income are providing 2x or more the return. Holding too much cash will likely be a significant drag on your total investment performance over the long run. You will hear that high yield and corporate bond spreads are “tight” – a finance term indicating that investors are not being paid much to take on the extra risk of the potential default of a corporate bond as compared to a treasury. I agree compared to what we have seen historically. The problem is, just like overvalued stock markets, those tight spreads can continue for a while. Spreads have been tight for 18 months and I expect them to stay that way short of a major recession. So waiting for the spread to widen is sorta like waiting for a stock market crash – you might be waiting for a long time with no returns. Its also worth noting that given the U.S. fiscal situation – high debts and deficits – many investors likely view the best large cap companies as equal too or better than the credit of the U.S. government. So it makes sense that the difference in interest rates between the two would be fairly low.

The Fed started cutting rates in September – finally – I welcome them to the party of economic weakness that we have been discussing for 24 months -  and the market is expecting 2 more Fed cuts this year. You can see from the yield curve that shorter terms rates have fallen significantly since the beginning of the year – really in the 2-10 year space. The market expects inflation and rates to moderate over the next year, but not fall too much over the long-term, which is why we have seen little to no movement in the 20 and 30 year part of the treasury curve. I continue to view “fair-value” on the 10-year treasury as something between 4.25 and 4.75% based on historical data. If the labor market weakens further and we have a recession, then the 10 year can fall into the 3% range, but if the economy powers through, which is what I expect currently, then I would expect the 10 year to be stable from here in the low 4% range.

What about other assets outside of Bonds?

Gold has also provided strong returns in a challenging environment, up more than 40% for the year. Gold is a great asset to own in this “light stagflationary” environment. IF the economy slows, gold will do well. If the economy speeds up and inflation goes back up, gold will also do well, so it’s the perfect asset to hedge both risks, which are very possible scenarios. I’ve been very positive on gold for the last few years, really since Covid. A lot of that has been based on the increased activity of central banks in the Gold market. They have sold or run off their U.S. Treasuries and bought Gold. There is some evidence that central bank buying slowed over the summer. Central banks are on track to buy about 1,000 tonnes of gold in 2025, which is down about 8% from last year. Investor flows into Gold have picked up as inflation rose in Q3 and concerns about the the labor market came back into focus so that more than replaced central bank buying for the year. Those investor flows can be finikky and as soon as the coast clears and the risks subside, then investors will move assets back to bonds that provide yield and stocks. So I would be thoughtful about continuing to add to Gold as it nears the 4,000 level and watch to see if central banks resume their purchase activity as everyone returns from the summer vacations in the fall.

We’ve covered a lot of ground, so I’ll try to summarize it all here.

We have gone round trip, we started the year looking for stagflation, then a recession back to a stagflationy and perhaps back towards a recession after today’s weak ADP jobs report. Economic growth is still positive, but slowing, and I expect it to remain that way for the remainder of the year. Core Inflation will likely rise back into the mid 3% range by year end given the price impacts of tariffs on consumers.

Its markets like these – high uncertainity – where diversification really matters. Not just in a theoretical sense, everyone always says to be diversified to manage risk, that’s easy. But in an environment where you can generate similar returns across lots of different asset classes, you are far better off owning different kinds of assets than just depending on one asset class, like stocks, to drive your portfolio’s growth. Stocks, Bonds, Gold, Real Estate, Infrastructure and other assets can help drive returns and some of those assets will likely outperform no matter which way the economy breaks. So diversification is really key to navigating this market perhaps in a way that it hasn’t been in recent years.

So I hope this perspective on markets has been helpful as you think about the rest of 2025. If you have questions about your investments and would like to discuss further, I’m always happy to connect. There is a link to schedule time in the show notes and I look forward to talking to you all very soon.