The resilience of the U.S. economy thus far in the face of tariffs is powering the stock market higher. The market-capitalization weighted S&P 500 Index advanced another +8.1% in the third quarter and is now +14.8% year-to-date through the end of September. The three-month and year-to-date returns for the equal-weighted S&P 500 were +4.8% and +9.7%. The market advance continues to be led primarily by the “Magnificent 7”¹(i.e. Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla) which in aggregate rose nearly +17% for the quarter but now represents approximately 35% of the S&P 500’s market capitalization, an all-time high level of concentration. The performance of our Clients’ portfolios for the quarter versus the cap-weighted S&P 500 can be easily explained as too much healthcare, not enough Mag 7. Our financial holdings also dragged on portfolio performance for the quarter after being a positive contributor in the first half of the year. Additionally, within technology, our software holdings were clear laggards for the quarter, detracting from healthy gains amongst our semiconductor and hardware names. Economic Outlook Even though our government is now collecting over $350 billion in annualized tariff revenue (a presumed headwind to corporate profit margins and/or consumer spending), there has yet to be any apparent adverse impact to economic growth. Many had believed that the pass-through of tariffs to consumers in the form of higher imported goods prices might be postponed as we work through inventories built ahead of the tariffs. Some also detected an initial reluctance by businesses to raise prices until there was greater certainty about tariffs. The more that time passes, however, it is becoming increasingly difficult to make a convincing case that there will be a meaningful demand impact. U.S. real GDP grew +3.8% quarter-over-quarter annualized rate in the second quarter due in large part to a big tariff-induced reversal in imports from the first to the second quarter. However, GDP growth has twice been revised upwards as consumer spending proved to be stronger than initially estimated. Consumption does not appear to have slowed in the third quarter, resulting in another quarter of +3.8% real GDP growth according to the Atlanta Fed’s GDPNow real-time model. The resilience of consumer spending belies concerns about the destructive impact of tariffs and weakening consumer sentiment. Additionally, heavy investment in data centers (construction, equipment, cooling, power, etc.) to support growing AI utilization is also boosting economic growth this year. Due to stronger than expected growth the past two quarters we now anticipate full-year 2025 GDP growth of +2-2.5%, up from our prior estimate of +1-1.5%. Meanwhile, inflation continues to firm as more of the tariff burden flows through to final prices. Core CPI² (excluding volatile food and energy prices) has now moved up to +3.1% y/y as of August, while Core PCE was +2.9%, both well-above the Fed’s 2% target with prices for both core goods and core services trending in the wrong direction. That said, the step-up in inflation due to tariffs has been more gradual than expected. We still expect core CPI to finish the year above 3%, perhaps closer to +3.5% y/y. While tariff uncertainty seems to be diminishing now (even though the legal basis is yet to be decided by the Supreme Court), the extension of tax breaks along with new ones included in the One Big Beautiful Bill Act should offer businesses greater certainty about fiscal policy moving forward, which is important for future planning. Meanwhile, the Federal Reserve has resumed interest rate cuts after becoming more concerned about the vulnerability of the labor market following significant downward revisions to previously reported job gains, which should further help with the availability and cost of credit. The Federal Reserve Open Market Committee (FOMC) lowered the federal funds rate by 25 basis points at its September meeting to 4-4.25% and signaled the possibility of at least two additional 25 bps cuts by year-end. Yet, the Committee finds itself in a challenging position with its dual mandate – maximum employment and stable prices – now at odds. As Fed Chairman Jerome Powell noted, there are no risk-free paths available to the Committee now. The Fed, which appears to have pivoted to worrying more about the labor market than inflation, runs the risk of focusing on the wrong thing at the wrong time. Increasing political pressure from the Trump administration, which is raising questions about Fed independence, is making the Fed’s job even more fraught than usual. Corporate earnings continue to hold up better than was feared back in the spring. After bottoming in May, consensus EPS estimates for the S&P 500 have moved higher, propelled mostly by rising estimates for the Mag 7, especially following much better-than-expected second quarter results. Outside of the Mag 7, however, profit revisions have remained muted. We have raised our full-year estimate for S&P 500 EPS from $260 to $266, +8% y/y, further narrowing the gap with the consensus estimate of $268. Our preliminary estimate for 2026 S&P 500 EPS is $300, +13% y/y. The level of investor interest in the AI theme continues to grow, giving the market an “all AI, all the time” feel. Indeed, the number of AI-related deal announcements recently and especially the associated dollar amounts defy credulity. There is no doubt that heavy investment in AI data centers and related infrastructure continues unabated for now. However, the circular nature of many of these deals raises eyebrows and begs the question whether a small number of self-interested players are attempting to perpetuate this spending cycle themselves to mask insufficient monetization thus far. There continues to be a disconnect between the spending on enabling infrastructure and the financial returns for those employing the technology. There are also practical limitations on the pace of AI capacity expansion, chief among them is power availability. As such, we find the current period reminiscent in many ways of the late-90’s internet bubble. While we remain enthusiastic about the potential for AI to ultimately be as transformational as the internet has been, we continue to question the timing. We are choosing to maintain a healthy level of skepticism to avoid overpaying for growth in the near term. The market has successfully surmounted a “wall of worry” this year related to tariffs, immigration policy, geopolitics, quality of government data, Fed independence, and now a government shutdown. The economic outlook for next year appears solid, backed by stimulative fiscal and monetary policies. As such, the market can continue to advance in the near term supported by rising profits, an accommodative Fed and growing AI enthusiasm. However, it is only prudent to point out that the S&P 500 is now selling at historically high valuations and is seemingly priced for perfection. Investor complacency is rising, financial conditions are easy, and signs of frothiness abound.