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EXCERPT FROM CLIENT LETTER October 2025  (see full letter above for tables, charts, and full commentary)

FROM THE DESK OF BOB CENTRELLA, CFA                                             October 6, 2025

For the second year in a row, the so-called September swoon failed to appear as the Fed lowered rates in what should be the start of a series of cuts barring inflation. But before we get into the meat and potatoes of my report, I’d like to get into the pasta and vino! As the summer ended my family spent a fantastic week+ in Italy. The weather was great, and the food and wine were as expected – tremendous. I have several friends who also went there this year, and all reported having a great time. I will say Rome was a bit crowded due to the Jubilee year for the Vatican, but it was civil. On the wine front we got to taste great wines in the regions we visited highlighted by Valpolicella and Amarone near Verona competing with Brunello and Vino Nobile in Tuscany. I decided to declare it a tie 😉.  My wine tip is for the sparkling wine lovers – Franciacorta Wine from the Lombardy region. A less expensive but tasty alternative to Champagne. I highly recommend you give it a try. There are several varieties to suit your palate. And the pinot noir rose goes great with pizza! As for travelling - if you can get there, “fare un viaggio in Italia”!

KEY TAKEAWAYS

1. U.S. Economy Avoiding Recession. The U.S. economy continues to defy recession fears. GDP growth remains positive, supported by strong consumer spending, business investment, and a healthy services sector. Q3 GDP growth is expected to be 3.8% The housing market however is struggling although certain areas are hot. The jobs market is still solid with unemployment low, but it has been weakening, putting pressure on the Fed to lower rates.

2. Inflation Is Cooling – Tariff pressure, where are you?  Inflation has steadily declined from its peak, and core inflation is trending lower. This gives the Federal Reserve more room to ease monetary policy in 2025, which could stimulate both economic activity and market performance. As of the end of August the CPI was 2.8% still above the preferred level but trending down. Where is the tariff pressure that has been expected? So far companies are finding ways to offset tariffs without raising prices too much.

3. More Fed Rate Cuts on the Horizon Markets are pricing in 2-3 more interest rate cuts from the Fed in 2025. Lower borrowing costs would boost housing, consumer credit, and business investment—while also supporting higher equity valuations. The Fed still remains data dependent, but calls are mounting for rate cuts from the Administration as well as many economists. Although rate cuts are expected, current interest rates remain at restrictive levels. This continues to pressure borrowing costs for consumers and businesses, slowing sectors like housing, autos, and small business investment.

 4. Corporate Earnings Rebounding. U.S. companies, especially in sectors like tech, healthcare, and financials, are showing robust earnings growth. Many have adapted to inflationary pressures and are now expanding margins and reinvesting in growth. Q2-25 growth came in at 11.7%, the 3rd straight quarter of double-digit growth. For Q3, the estimated growth rate for the S&P 500 is 7.9% on revenue growth of 6.3%. For Q4 the current estimate is for 7.1% EPS growth leading to a CY 25 rate of 10.8%. Stocks tend to follow earnings growth.

5. Technological Innovation Driving Markets.  The U.S. continues to lead in tech innovation, especially in AI, cloud computing, biotech, and clean energy. These sectors are fueling capital investment, productivity gains, and investor enthusiasm. The large data center companies such as Microsoft, Google, Meta and Oracle are spending $ hundreds of billions on building out infrastructure while almost all companies are adopting AI into their businesses. Some wonder if we are in an AI bubble. Time will tell if all the spending on AI can drive returns. Bulls argue we are still early in the process, and it will continue for many years to come.

6. Equity Valuations Are Stretching.  Major indices like the S&P 500 and Nasdaq are trading at historically high price-to-earning (P/E) ratios, especially in tech. This raises concerns about a potential correction if earnings don’t continue to beat expectations. The forward 12-month PE ratio is 22.5x. above the 5-yr average of 19.9 and 10-yr average of 18.6x. It ended Q2 at 22.1x. Much of the PE ratio is driven by the top 50 stocks which trade at levels above that valuation. Conversely, defensive (HC, Staples, Utilities) and cyclicals (industrials, financial, materials) are trading at below-market multiples. These sectors can lead especially if the Fed lowers rates. Small and midcap stocks would also do well in a declining rate environment.

7. We Are Entering a Seasonally Strong Q4, But...  The 4th quarter has historically been the strongest for stocks. But October has been the month for potential corrections and we havent’t had a correction since April. The market is up 38% from that bottom! It is certainly possible for stocks to pause before finishing the year on a strong note.  A 5-7% correction although tough to stomach would be healthy for stocks and set us up for a YE rally.

8. Bond Yields have finally moved down a bit.  The Yield curve is mostly normalized except for the short end (1-mo higher) although spreads are tight. If the Fed continues to lower rates, we should finally see a normal curve with short rates below longer-term maturities. But the steepening is more likely to occur with short-term bond yields declining rather than LT rising. A lower 10-yr rate is needed for mortgage rates to fall.

1-mo       1-yr         2-yr        5-yr       10-yr       20-yr       30-yr
4.13%    3.64%    3.57%   3.7%    4.12%    4.68%    4.71%

9. Government Shutdown – big deal or not? The federal government shut down after 9/30 and it looks like we could be in a stalemate for a bit. History has shown that the market and economy tend to brush it off, but headline risk could bring some volatility to markets. Also, with no economic data, the Fed decision to lower rates could be hampered. Still, a prolonged shutdown would not be good for stocks.

 SUMMARY AND CONCLUSION

The market has continued to rock and roll since April’s “Liberation Day” bottom. The S&P has climbed 38% from the bottom as I mentioned and presently it looks like it wants to go higher.  As with the end of each quarter we are ready to enter earnings season. Last quarter was a definite upside surprise (over 80% of companies beat) which drove stocks higher. This quarter, expectations are a little higher and with stock valuations somewhat elevated, you could see a letdown if companies do not beat earnings and are less enthusiastic about Q4.

Due to the history of a seasonally strong Q4 for stocks, many market watchers are looking for the rally to continue. I also fall into this camp and would use any October weakness to buy stocks heading into November and year-end. Risks to a strong finish include higher inflation and a more wary Fed. If the Fed pauses its rate decreases, I expect the market to react negatively. But it would take a big tick up in inflation for the Fed not to continue to lower rates. 

I still recommend a diverse equity portfolio with Large cap stocks leading but with exposure to Mid and Small caps (under 10% combined). If the Fed lowers rates further, that would benefit smaller stocks as well as cyclical companies. International stocks are having a great year and should continue to be part of the portfolio mix. For balanced portfolios, US bonds offer coupon returns at this point. So, a 4.0-4.5% annual bond return, although not great in relation to stocks, is not bad for a risk-free return. Finally, Gold, which is up 47% this year, continues to offer a good inflation hedge as an alternative asset class. Final advice, we continue to hold on and use weakness for buying opportunities.

As always, feel free to contact me with questions or comments. Have a great fall!

Bob

  
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Bob Centrella, CFA
Managing Partner
Forza Investment Advisory, LLC

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