Business Update
This year has been one of continued growth and progress for our firm. Forrest Financial Partners expanded the number of families we serve, and total assets under management have grown 35% year-to-date. Looking ahead, Peter and I plan to strengthen our team in early 2026 and roll out several enhanced client services that build on our holistic approach to wealth management. More details will follow soon.
Market Overview: A Relentless Rally
Markets delivered another strong quarter, with the S&P 500 gaining approximately 7.9% in Q3 and pushing year-to-date returns solidly into double digits. The rally – now extending more than 110 trading days without a notable pullback – ranks among the strongest in recent history.
AI-related spending remains the dominant narrative. Companies across sectors are pouring hundreds of billions of dollars into data centers, power infrastructure, and chip capacity to meet the growing demand for generative AI. That spending has been a powerful engine for market performance, with AI and growth-related stocks driving the majority of market returns, while value and defensive stocks lag.
However, while the technology-heavy indices continue to lead, this quarter also saw a subtle but important shift: small-cap stocks began to regain ground. The Russell 2000 outperformed the S&P 500 during Q3, a sign that investors may be positioning for a broader market advance beyond the mega-cap growth leaders.
The Fed Turns a Corner
In September, the Federal Reserve initiated a long-anticipated rate cut, lowering the federal funds rate by 25 basis points to a new range of 4.00%–4.25%. Policymakers acknowledged softer employment trends and an easing inflation backdrop, signaling that future moves will remain data-dependent.
This marks a shift in tone – from debating when easing will start to how it will evolve. The new phase of monetary policy has been broadly supportive for risk assets, and while the timing of future cuts remains uncertain, the market has so far interpreted the Fed’s flexibility as a tailwind for both equities and bonds.
Is AI in a Bubble?
It’s a question many investors are asking, and understandably so. The “Magnificent Seven” mega-cap tech firms – names synonymous with AI investment – have driven roughly half of U.S. stock market gains this year. AI has also absorbed over 60% of all venture capital funding in 3Q2025, underscoring how concentrated enthusiasm has become.
Valuations, by most measures, are elevated. The top 10 companies in the S&P 500 now account for more than 40% of the index’s total market capitalization, and nearly half of recent GDP growth has been tied to technology capital expenditures. Some of these investments even appear “circular” – AI firms investing in each other’s infrastructure and funding rounds – a dynamic reminiscent of past speculative cycles.
That said, the comparison to the dot-com era has its limits. Today’s leading firms are not built on speculation alone. Most have strong balance sheets, recurring revenue streams, and real cash flow generation. According to Bloomberg Intelligence, earnings for the Mag Seven are expected to grow roughly 15% in 2026, supported by double-digit revenue growth – a far cry from the profitless tech boom of 1999.
The real test will come in productivity. For AI to justify its current valuations, we’ll need to see measurable improvements in output and efficiency (and thus, margins) – not just more spending. That validation could take time, and in the interim, markets may oscillate between excitement and skepticism as data begins to reveal whether AI-driven investment is translating into tangible returns.
A Case for Broader Opportunity
While the leadership of a few large technology companies has been remarkable, concentration also amplifies risk. Markets rarely move in a straight line, and periods of extreme outperformance are often followed by rotation.
We believe we are approaching a stage where market breadth improves – where smaller, more economically sensitive companies, as well as defensive and value-oriented sectors, begin to reassert themselves. That’s healthy for long-term investors, and it supports our emphasis on balance and diversification rather than chasing narrow themes.
The third quarter’s small-cap rebound and the rotation into credit markets both underscore this shift. The Bloomberg U.S. Aggregate Bond Index is up roughly 6.4% year-to-date, and high-yield credit has performed even better, advancing about 7.4%. These segments have helped offset volatility and provide attractive income opportunities at a time when yields remain compelling.
Portfolio Positioning: Discipline Over Prediction
Forrest Financial Partners portfolios continue to reflect our conviction in diversified, fundamentals-driven investing. Our allocations remain balanced across equities, fixed income, cash alternatives, and opportunistic credit exposure – with liquidity as a key focus. We don’t chase themes; we align positions to time horizons, liquidity needs, and the capacity to stay invested through volatility.
That discipline has served our clients well through this rally, and it remains essential as markets enter a potentially more nuanced phase. Our approach is not to time the next rotation but to remain positioned for multiple outcomes – including the possibility that market leadership broadens and volatility returns.
Looking Ahead: Key Risks and Catalysts
We remain constructive on the outlook but mindful of several evolving dynamics:
- The Fed’s next moves: The first rate cut may not be the last, but future policy decisions will hinge on employment data and inflation trends.
- Tariffs and trade: Shifts in trade policy continue to influence supply chains and cost structures globally.
- Earnings execution: Corporate results have been solid, but expectations are high. Companies will need to deliver real margin improvement to justify valuations.
- Valuation pressure: Elevated multiples leave little room for disappointment, especially in concentrated sectors.
- Rotation potential: As AI enthusiasm matures, leadership may broaden toward smaller and value-oriented companies – a welcome normalization for long-term investors.
Our base case remains one of cautious optimism. Economic growth is moderating, but not contracting. Inflation continues to drift lower, and the Fed’s recent pivot supports a more constructive environment for both equities and bonds. That said, markets rarely move without pause, and we would not be surprised to see a period of consolidation after such an extended rally, particularly with valuations as high as they are.
If you’d like to review your current allocation or discuss portfolio adjustments in light of these developments, please don’t hesitate to reach out. We’re here to ensure your plan remains aligned with both current conditions and your long-term objectives.
Best,
Chris Stevenson, CFA & Peter Hughes, CFA, CPWA®, CEPA®
