Investment Outlook Q3 2025: The sum of fears is fading

Key observations: 

Economic outlook  

• Concerns about a recession and collapsing company earnings have given way to improving leading indicators and sustained earnings growth.
• Equity markets have rebounded strongly through the third quarter, with credit spreads steadily narrowing.
• Major US legislation has been passed, supporting higher government spending and more business‑friendly regulation, including for digital assets.
• A reset of key institutions has begun, starting with the Federal Reserve and the Bureau of Labor Statistics. Two Fed governors have already departed and future appointments, including the next Chair, are likely to favour easier financial conditions.
• Early signs of economic recovery are emerging in both the US and Australia as recession fears retreat.
• Company earnings are expected to expand into their valuations as this recovery builds.
• Inflation should lift modestly due to tariffs but is unlikely to pose long‑term issues.
• Labour markets have softened slightly worldwide. While not a drag on growth, this does add to central banks’ bias to cut rates over the next 12 months.
• We expect the multi‑year weakening trend in the US dollar to continue, though not without interruptions.
• Money supply is rising steadily, seen in both national and global M2 measures, expanding bank lending, and increased government spending.
• Interest rate cuts remain in view, with both the RBA and Federal Reserve expected to deliver one or two more before year‑end.

Market Scenarios for 2025/2026  

• Base case: We expect equity markets to finish the year higher, supported by the rebound from April’s US tariff disruptions, easing geopolitical risks, and fading recession concerns. Encouraging signs include expectations of further rate cuts, strong US second‑quarter earnings, rising monetary aggregates, and the early stages of an economic recovery. Markets may see volatility in September and October, but our base case remains positive. Political and geopolitical risks, while present, are not strong enough to derail a constructive outcome.
• Positive scenarios: Consumers and corporates remain resilient, supported by strong balance sheets, high savings, and low leverage - this significantly reduces recession risk. The impact of tariffs is likely overstated, as they touch only a small part of the economy. Productivity gains driven by AI could boost margins and fiscal balances. The ‘One Big Beautiful Bill’ will channel government spending through 2026, extending the economic and market cycle. With an eye to the 2026 midterms, the Trump administration is likely to maintain a policy bias towards stimulus, creating a supportive backdrop for equities and risk assets.
• Negative scenarios: A risk remains that US inflation holds stubbornly above 3%. This would slow the Fed’s pace of rate cuts despite muted growth, creating a “stag-flation” backdrop. US Treasuries could come under pressure from higher global bond yields and reduced foreign demand, driving volatility in both bond and equity markets and possibly forcing Fed intervention. In the EU, defense and infrastructure spending is rising toward 5% of GDP (from ~2%), requiring significant debt issuance at higher yields. This could shift investor capital away from US Treasuries towards EU bonds, pushing global bond yields higher. While this supports growth and corporate activity in Europe, it adds structural upward pressure on yields worldwide.
• Credit markets: Credit spreads remain tight, especially in the US, and are narrowing back toward historic levels in Australia. This signals an impressive recovery after the widening spread of March and April, with sharp contractions through May.
• Equity markets: Despite challenges earlier in the year, Q2 earnings in the US and FY earnings in Australia were encouraging. Overall, we see the year ending with positive equity returns, while recognising that seasonal volatility through September and October remains a risk.
• Political and geopolitical watchpoints: The Fed’s leadership transition looms large, with Governor appointments ahead of Chair Powell’s planned retirement in early 2026. China and Russia continue to exert influence in their regions and on global commodity and energy markets.

Long-term themes 

• Geopolitical and policy volatility is here to stay and must be factored into investment decisions.
• Climate change costs are rising, particularly as data centres and AI drive significant new energy demand.
• ESG as an investment theme is fading, with labels being removed or downgraded.
• High government debt levels create challenges, both in regular refinancing cycles and in times of financial stress.
• Technology adoption is accelerating, with AI, blockchain, hyperscale data, and computing power converging.
• Popular investment themes often overshoot, creating cycles of over and under valuation for thematic strategies.
• Younger generations continue to challenge traditional institutions against the backdrop of a more polarized society.

Current insights that link to the long-term

• China’s recent military parade showcased advanced weaponry and demonstrated a closer Russia-China-North Korea alignment, highlighting ongoing geopolitical risks that can both shock and restore markets.
• Gold remains well supported as rising government debt issuance and higher yields raise concerns. Central banks have already announced net gold purchases into 2026 to further diversify their reserve portfolios.

Tactical Asset Allocation 

Factor	Rationale
Fundamental – Positive	Leading indicators in the US and Australia now point to the early stages of economic recovery. Earnings growth is re‑accelerating, supported by easier policy settings, corporate resilience, and ongoing fiscal stimulus. Credit markets remain well supported, labour markets are softening but not weakening materially, and monetary aggregates continue to rise. These factors provide a constructive backdrop for equities and risk assets.
Valuation – Moderately Negative	After the rebound in equities through the third quarter, valuations once again look somewhat stretched relative to trend. However, the risk of an earnings collapse has diminished, and ongoing earnings growth is expected to help equities grow into their multiples. Valuation remains a modest headwind in the near term, but less concerning than earlier in the year.
Technical – Neutral	Equity markets globally have shown strong technical momentum following the tariff‑driven disruptions in April. Credit spreads have narrowed dramatically after their March–April widening, reinforcing market resilience. Sentiment has moderated amongst retail investors while positioning is more balanced.  New 52 week highs outnumber lows in stocks, with market breadth in other measures balanced. Seasonally, some volatility is typical into September–October, but the overall technical setup largely neutral.
Overall view for growth asset classes.	With fears of recession fading, policy settings easing, and earnings improving, the backdrop is supportive for growth assets. While valuations remain elevated, the improvement in fundamentals make for a neutral tactical allocation outlook and we would look for opportunities to add to risk if periods of weakness arise from seasonality.

 

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.