Cornerstone 3rd Quarter 2025 Commentary

There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things. – Niccolo Machiaveli

The fragility of a sytem increases with its degree of stability. – Nassim Taleb

Antifragility is beyond resilience or robustness. The resilient resists shocks and stay shte same; the antifragile gets better. – Nassim Taleb

The VIX is a measure of equity volatility in the market.  It is often referred to as a “fear gauge.” We could also consider it a measure of investor complacency.  As investors’ fears subside and they become more complacent, the total volatility in the market declines.  Because the VIX is a measure of volatility, it is also true that as the market establishes a consistent trend either up or down, the VIX will also decline.  In the following chart of the VIX, one can clearly see the market angst surrounding the onset of tariffs earlier this year and the growing complacency of markets as those tariffs failed to dramatically impact the corporate profit margins or the U.S. economy.

Along with the decline in investor fear and the volatility stemming from it, the market rally has consistently been led by a narrow cadre of stocks: all the usual suspects, of course, but particularly by NVIDIA.  In and of itself this is not necessarily a bad thing.  NVIDIA has generated fantastic earnings, has experienced tremendous growth, and become the backbone of the AI boom.  What, then, is the problem? 

Perhaps there is not a problem, but then again there is an old saying, markets are at their weakest when they are narrow and at their strongest when they are broad.  As we noted, the volatility in the market has declined of late, and equity indexes have continued to march higher.  A rising tide does indeed lift all boats, but perhaps this tide is not lifting all boats equally.

Concentration is not all bad, but it does have its challenges, not the least of which is that it makes it very difficult for diversified investors to keep up with market leaders.  Further, in today’s passively driven market, fund flows into passive index alternatives act like a self-fulfilling prophecy, pushing market leaders higher regardless of valuation.

Tech-related earnings remain positive, and while valuations are stretched, the AI boom is indeed changing the world.  The remainder of the market does not look all that expensive, and perhaps we may yet see a broadening of this market.  Without some sort of broadening, it will become ever more difficult for the AI trend alone to pull the market higher.  Stocks like NVIDIA, Meta Platforms, Alphabet, Microsoft, and Tesla are investing so heavily that the ROI hurdle rate keeps going up.  Microsoft made money during the Dot-Com Bubble, but investors often forget that following that frothy period, Microsoft stock went sideways for ten years before resuming its upward trend.  Current tech/AI stocks are valuable companies making real money, but there are limits to growth and the expansion of any particular technology if for no other reason than the rest of the economy must be able to absorb the technological change.  We remain very optimistic about the future of AI and its impact on the global economy, but a significant amount of future growth expectation is built into the mega cap tech complex. It is the combination of high expectations, cross investment, and concentration that makes this market fragile and, in our view, highly susceptible to sudden dramatic declines.

As previously noted, the equity and bond market rally continued in the third quarter of 2025.  Virtually every major asset class rallied during the period with gold ending the third quarter at $3,858 and breaking the $4,000 mark not long after quarter end.  The precious metal has been on a tear this year eclipsing even the strong rally in large cap U.S. tech.  Based off the daily London spot price, gold is up just under 47% on a year-to-date basis, and that rally has continued into the fourth quarter.  The rally does indeed have legs as it is most likely based not only on future inflationary fears but also on strong demand from the central banks of the world.  Can gold go higher, you ask?  It certainly can and is likely to do so.  However, we remind our readers that the precious metal does not pay a dividend.  When gold hit a high of $850 in January of 1980, the precious metal did not eclipse that high on an inflation-adjusted basis until this year. (That’s a long time to go without any income!) Gold can be a great portfolio diversifier, but it is not always the hedge that it is thought to be. It is interesting that Morgan Stanley’s Chief Investment Officer Mike Wilson recently suggested that investors alter their traditional 60/40 portfolio (60% Equities/40% Bonds) to a 60/20/20 portfolio (60% Equities/20% Bonds/20% Gold).  He further named gold the “anti-fragile” asset.  This is a radical departure from traditional asset allocation.  Even with a strong bullish case for gold, allocating 20% of a moderate growth portfolio to a volatile, non-income producing asset seems like a bit of a stretch to us, particularly after that asset has just appreciated 50%.

Bitcoin, the new form of digital gold, also rallied during the quarter briefly eclipsing $120,000 before falling back to around $115,000 to end the quarter.  While the use case still seems a bit shaky to us, there is no doubt that interest in crypto continues to grow and the price of bitcoin along with it.

While investor attention, for the most part, remains fixed on U.S. large capitalization tech-related companies, small cap stocks staged an impressive rally during the quarter with the Russell 2000 Index up over 12% for the period.  The rally was largely driven by low quality speculative companies, but it was impressive, nonetheless.  REITs also managed to eke out a positive quarter with the NAREIT Index up 2.47% for the quarter.  REITs have been unloved of late, but with interest rates falling and rising demand for data centers, they may offer an opportunity to investors in the months to come. 

International stocks also continued to perform well during the third quarter.  Developed market equities, along with their emerging markets counterparts, are having their best year since 2018.  The MSCI EAFE gained another 4.77% during the quarter bringing its year-to-date total return to 25.14%.  Emerging markets rallied strongly, as well, up almost 11% during the quarter and nearly 28% for the year-to-date period. International small cap was another stealthy strong performer, up over 7% during the quarter and nearly 30% on a year-to-date basis.  Of course, international securities owe much of their performance in 2025 to dollar weakness, but even without a 10%+ decline in the dollar, international assets are performing quite well, and they remain relatively cheap when compared to U.S. markets.

As expected, the Fed lowered the Fed funds rate by 25 basis points at their September meeting.  While the move was expected, the comments from the Fed indicated they anticipate additional cuts during the remainder of 2025. Given the timing of our writing, we have already witnessed one additional cut at their meeting in late October.  While chairman Powell left open the possibility that the Fed could pause again before the end of the year, the market continues to expect an additional cut at the December meeting.  With the government shutdown ongoing and data limited, it seems unlikely that the Fed will surprise markets with a pause.  Rather, we think it likely the Fed will indeed cut an additional 25 basis points at the December meeting.  While these cuts are likely already priced into markets, they should continue to boost fixed income returns.  

Bond markets have performed well in 2025.  The third quarter of the year was no exception.  The Bloomberg Aggregate Bond Index was up approximately 2% for the quarter and is up a bit over 6% on a year-to-date basis. Yields remain attractive, and the long end of the curve has remained relatively well anchored. We expect that diversified fixed income portfolios could end the year up 7-8%, and given current yields, 2026 is looking quite positive as well.  The curve is likely to continue to steepen, and unless inflationary data worsens significantly, then the long end of the curve should remain relatively flat and possibly even decline a bit if the economy slows in 2026.  Given the uncertainty surrounding tariffs, a healthy dose of fixed income may once again act as a solid volatility buffer for diversified portfolios.  Given equity performance over the past few years, forward-looking expectations are somewhat muted, and fixed income may be more attractive than many investors realize.   

Cornerstone Management Inc. is a Registered Investment Advisory Firm. Although the information in this report has been obtained from sources that the Firm believes to be reliable, we do not guarantee its accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. This report may only be dispensed with this disclosure attached.