October brought a continuation of the bull market for equities, with the S&P climbing steadily to fresh all-time highs. Even after a couple soft days at the end of the month, the market closed with a 2.3% MTD gain, taking YTD total returns to 17.5%.
Inflation data helped keep the markets happy by coming in slightly below expectations. Prices continue to rise at a brisk 3% rate, which is well above the Fed target of 2%. However, the newly deployed tariff policies do not (at this time) appear to be causing the sharp spike in inflation that was originally feared.
Positive sentiment was also bolstered by third quarter gross domestic product (GDP) data. It appears that tariff front-running helped boost third quarter GDP, possibly as high as 3% — similar to the amazing 3.8% growth rate we saw in the second quarter. It’s clear that this was a one-time spike in activity, largely due to import activity, which will not be repeated. Most analysts expect a protracted period of sub-2% GDP growth in upcoming quarters.
Federal Open Market Committee (FOMC) expectations
The FOMC met market expectations with another downward adjustment to the Fed Funds rate, taking overnight rates to 4.00%. The follow-up commentary by Chairman Powell made it quite clear that another cut in December is not a foregone conclusion. The FOMC is divided between those who want to be proactive (cut now in anticipation of future softness) and those who wish to be more reactive (with future cuts dependent on how the data comes in).
There is no question that the overall bias of the Fed is toward lower rates over the next several quarters. That said, the speed and magnitude of the cuts is a contentious issue.
The Fed is concerned about softness in the labor market and is currently operating without any fresh monthly data from the Bureau of Labor Statistics (BLS) due to the current budget impasse and government shutdown. Real-time data from online employment sources (i.e. Indeed) indicate that job openings are continuing to fall, and therefore it is reasonable to expect that payroll data will continue to deteriorate once the BLS is back online.
Bifurcated economy
Based on these market factors, we are experiencing a bifurcated economy, with virtually all the real consumption growth coming from the top 20% of households (based on income). The lower 80% of households are struggling to keep up with inflation, and delinquencies for auto loans and credit cards are rising.
In the commercial space, the vast majority of capital expenditures appear to be coming from the small group of companies involved in the expansion of the artificial intelligence (AI) boom. Because of that, the lion’s share of earnings and equity gains are narrowly concentrated within the AI space.
We believe the FOMC seeks to bolster the “bottom 80%” of companies and households, hoping to broaden out the economic growth patterns in 2026. Assuming inflation doesn’t surprise us by spiking higher, we expect the Fed to steadily reduce overnight rates throughout 2026, ultimately landing around 3.25% at the end of 2026.
Moderately lower rates should help businesses feel more confident heading into 2026, which could improve the outlook for capital expenditures outside of the AI space – bolstering activity, jobs and the overall economy. Lower rates will also bring some relief to households in the form of lower mortgage and consumer credit rates.
Government shutdown
The Federal Government shutdown drags on and is likely to become the longest shutdown in history. The markets are still unfazed by the histrionics in D.C. These types of shutdowns have historically had very little impact on either the economy or markets. Nevertheless, some areas are feeling the burn. For instance, as air travel becomes more constrained, the noise around this topic will likely increase dramatically. We believe that a resolution will be found soon, and economic and market damage from this shutdown will be negligible.
The ongoing risks will remain the same:
- Inflation could push sharply higher due to tariffs, stopping the Fed easing campaign,
- The very weak payroll data could foretell a serious economic slowdown, pushing consumption and activity sharply lower (even amongst the top 20%) before the Fed can rescue the economy via lower rates.
We do not foresee either of those outcomes as the most likely base-case scenario at this time, but they are the primary risks headed into next year.
October economics in summary
Another month of strong equity returns continues to push 2025 results well ahead of expectations, but the challenges are clear. Economic and market expansion are being driven by a narrowing group of households and companies, which is not a viable long-term plan for the world’s most dynamic economy.
Overall U.S. economic activity appears to be headed for a below-average patch, and the labor market is in a weakened state. Inflation is still too high, but the FOMC believes it will taper off on its own in 2026. The equity markets have gotten confirmation that interest rates are headed lower again, which should help broaden economic expansion throughout 2026. The magnitude and speed of the rate-cutting campaign are still hotly debated within the FOMC.
We are becoming more optimistic that we could be back on a strong economic trajectory as we move through 2026 but remain cautious at this time due to the multiple risks to the economy and lofty valuations in the equity markets.
We continue to remain neutral in our risk allocation, believing that the time for heavier risk exposure is still yet to present itself.
We are here to provide our clients with peace of mind about their financial future. Anchoring to a sound, long-term financial plan will help everyone weather storms like these. We will remain disciplined, and consistent in our strategies and philosophies. We are confident that together we will manage our way through this (hopefully brief) challenging time.
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UMB Investment Management and UMB Private Wealth Management are divisions within UMB Bank, n.a. (a subsidiary of UMB Financial Corporation) that manage active portfolios for employee benefit plans, endowments and foundations, fiduciary accounts and individuals. UMB Financial Services, Inc., Member FINRA, SIPC, offers broker/dealer and investment advisory services to retail and institutional investors and is also a subsidiary of UMB Financial Corporation and is an affiliate of UMB Bank.
Note that “we” and “our” used throughout this letter refers to UMB Investment Management’s thoughts and expectations.
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