Quarterly Market Commentary – Mosaic Model Portfolios
In their quarterly update, the Multi-Asset portfolio team at Madison Investments discusses the events of the quarter, and provides an outlook for the markets moving forward.
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Market Recap – Third Quarter 2025
For all intents and purposes, the third quarter of 2025 was another exceptional period for investors, the S&P 500 was up another 8.1%, international stocks (MSCI ACWI ex-US Index) gained 6.9%, and bonds (Bloomberg US Aggregate Bond Index) tacked on 2.0%. However, despite the handsome absolute gains all-around, for those light on mega cap growth stocks, it felt like another “AI or die” quarter from a relative standpoint as the Magnificent-7 (Mag-7) and other AI associated stocks vastly outperformed in a continuation of the market action we’ve seen since the launch of ChatGPT in late 2022. The return differential was stark, the Mag-7 averaged a near 18.0% return, versus the median S&P 500 stock up just 4.4% and the 4.8% gain for the S&P 500 Equal Weighted Index.
Also notable was the performance of higher beta and lower quality stocks, evidenced by the 13.0% return on the S&P 500 High Beta Index (now up 64.0% off the April low!) and the 12.4% showing from the small cap Russell 2000 Index. Quality stocks were left behind in the quarter’s momentum thrust with the S&P 500 Quality Index up a solid, yet relatively pedestrian 3.1%.
Markets were further boosted by shifting expectations for easier monetary policy (interest rate cuts) from the Federal Reserve (Fed). July’s jobs report, released on August 1st, disappointed to the low side, but the kicker was in the large negative revisions to the May and June figures, where over 250,000 jobs were wiped away. The negative shock cemented a 0.25% rate cut in September and pushed up odds for an additional 0.50% of rate cuts over the remainder of the year. Interest rates fell and rate sensitive stocks, like small caps, jumped with 10.5% (85%) of the Russell 2000 Index’s 12.4% return coming in August/September. The fall in rates was even more beneficial to bonds, where 2.3% (113%) of the Bloomberg US Aggregate Bond Index’s 2.0% return was made in the final two months of the quarter.
Performance
Our Multi-Asset portfolios provided solid absolute returns for the quarter but fell short of blended benchmarks on a relative basis largely due to the constitution of our U.S. equity allocations. Our portfolios are notably underweight the valuation-stretched Mag-7 and AI stocks that, as mentioned above, dominated the U.S. equity market in the third quarter. Portfolios were also held back by our preference for quality within our small cap allocation and an overweight to the Financials sector. Relative returns within our international equity allocation fared better, led by our overweight to emerging Asia and Japan.
Fixed income performance was generally in line with the Bloomberg US Aggregate Bond Index benchmark across most portfolios as our overweight to the securitized sector proved to be beneficial.
Outlook & Positioning
As we move into 2025’s final act, we marvel at the S&P 500 Index’s astonishing 35% run off the April low. A ricochet trajectory not typically seen outside the aftermath of a violent bear market. It appears we’ve reached a point where investors’ level of exuberance can only be rivaled by their level of cognitive dissonance. We commented last quarter that markets have been trading like uncertainty has been eradicated, yet it most certainly remains. The economic distortions of the tariff saga are immense, and the ripple effects are only now just starting to come to light as the deliberations and trade deals carried on until early August. Investors are all-in on AI, yet there is little evidence that the hundreds of billions of dollars in capital thrown at the industry have a viable path to substantial revenue generation. The Fed’s focus has pivoted away from price stability to a weakening labor market despite inflation reaccelerating, continuing to increase at a rate 50% above their target, and their collective wisdom not seeing a return to 2% until 2028. The U.S. equity market trading at nearly 23x 12 months forward earnings doesn’t appear to believe much, if anything, can go wrong. The same can be seen in the corporate bond market where interest rate spreads over U.S. Treasuries (credit spreads) sit near historic lows.
Gold continues to send a cautionary message, up 16% in the quarter and has gained over 40% in 2025 alone. Investors typically turn to the precious metal for crisis insurance and/or a hedge against inflation/currency depreciation. Clearly the shifting geopolitical landscape and deteriorating US government financial position, with no signs of fiscal restraint, are spooking a large contingent of market participants. We heed the message.
Resilient consumer spending is holding recession risk in check. There is no doubt that the labor market has slowed, but it’s not showing undue signs of stress. Turnover has stalled with very little hiring or firing happening in the aggregate. To us, this is another sign that uncertainty remains in the minds of business leaders awaiting better clarity on the economy. However, until we see a material rise in unemployment claims, the U.S. economy will likely remain stable.
In conclusion, it should be clear that we don’t share the market’s view of a goldilocks future, yet we’re cautiously optimistic. We see pockets of the U.S. equity market as teetering on irrational exuberance, but there are opportunities in companies beyond the AI sphere where valuations are less demanding. Given the uncertain backdrop, elevated valuations, and investor overconfidence, we continue to stress quality across our asset allocation portfolios. True to our participate and protect philosophy, we don’t think it’s a good time to be swinging for the fence.
We truly appreciate your confidence and partnership.