October 9, 2025 – Tariffs were raised this year significantly, but corporate earnings have been coming through surprisingly strong. The U.S. Government shutdown enters its second week, though overall economic growth continues. Inflation has been stuck above the Fed’s preferred level of 2% and unemployment remains relatively low, although the Federal Reserve has embarked on an interest rate easing cycle. Stock markets around the globe have reached record highs, but so has the price of gold, a typically safe-haven investment. If it feels like an episode of the Twilight Zone, you are not alone.

The Twilight Zone
The Twilight Zone was a science fiction television series created and presented by Rod Serling, which ran for five seasons on CBS starting in October 1959. Each episode presented a standalone story in which characters found themselves dealing with unusual events, an experience described as entering “the Twilight Zone”. The phrase “twilight zone” has been part of our vernacular for over 60 years, used to describe surreal experiences, some of which we may be experiencing now. Tariffs were raised this year significantly, but corporate earnings have been coming through surprisingly strong. The government remains closed for the most part, however consumers continue to spend at reasonable rates and GDP growth continues. Inflation has been stuck above the Fed’s preferred level of 2% and unemployment remains relatively low, although the Federal Reserve has embarked on an interest rate easing cycle. Gold, typically a safe-haven investment, has reached record high price levels, but so have risk-on assets, including equities. The twilight zone indeed.

The Third Quarter – A Surprise Ending
The third quarter of 2025 turned out to be a solid one for equity markets. The S&P 500 gained 8.1% in the third quarter, while the equal weighted S&P 500 gained 4.8%. For the year, the S&P 500 is up 14.8% and the equal weighted index is up 9.9%. Value stocks gained 6% in Q3 and small cap stocks added about 9%. International equities added to positive performance in the quarter as well. Considering that the S&P 500 ended the first quarter down 4.3% as tariff turmoil and budget negotiations were injected into economic and investor calculations, the rebound in markets in Q2 and Q3 provided a welcome lift. The Magnificent 7 stocks still account for about one-third of the weighting of the S&P 500 index and about 40% of the returns this year so far, but market breadth has improved somewhat. In fact, all sectors of the S&P 500 are in positive territory so far this year.

Government Shutdown – More Noise Than News
Despite the government shutdown entering its second week, along with continuing tariff and trade gyrations, the path of least resistance in markets has been higher. This is partly due to a combination of a renewed Fed easing cycle, a fairly solid U.S. economic backdrop and continued expected corporate earnings growth. The upcoming earnings season will focus on elevated capital expenditures for AI infrastructure, tariff mitigation measures by corporate management teams and the level of consumer resilience. If the government shutdown drags on too long, we may be in a vacuum regarding inflation and payroll data collected by government agencies, so we (and the Fed) will have to rely on other sources of data. However, as Rod Serling noted, “There is nothing in the dark that isn’t there when the lights are on.” On the other side of the ledger, labor market paralysis is of concern, along with worries surrounding an AI bubble and tariffs driving consumer goods prices higher. So far, markets have shrugged off these concerns as more noise than news.

Entering Another Dimension
Consumer spending has remained resilient, supporting continued economic growth. The latest GDP estimate is for 3.8% growth in the third quarter following 3.8% GDP growth in Q2. Looking ahead, spending by consumers in the upcoming holiday shopping season is forecast to grow by 5.3%. Inflation has been sticky, but running in the 2.5-3.0% range this year. Labor markets have been sluggish, though the unemployment rate remains relatively low at 4.3%. Amidst this economic backdrop, the Federal Reserve began cutting interest rates in September, and two more cuts of a quarter point each are expected in the fourth quarter.

Despite all of the hand-wringing about tariff impacts, companies appear to be mostly managing through tariffs. A declining U.S. dollar, which has fallen about 10% this year, is providing a modest tailwind. Corporate earnings are projected to grow about 10% for the full year 2025 and 14% in 2026, with growth expected for both Q3 and Q4. Crude oil and natural gas prices also declined in Q3, while average gasoline prices have fallen about 2% from last year’s levels, providing some relief to increasing cost pressures from tariffs and a small effective tax cut for consumers.

It is worth noting that AI spending may be helping to sustain growth that might otherwise have faltered under these conditions. In terms of market exuberance, corporate conditions and profitability are much improved from the dot-com bubble era. Nevertheless, the question remains whether this is a “new normal” or a rhyme of history. We may be travelling through another dimension “into a wondrous land whose boundaries are that of imagination,” but it is more likely that we have seen this episode before.

Scott Bakula (Quantum Leap and Star Trek: Enterprise) turns 71 today along with John O’Hurley (J. Peterman from Seinfeld). Also, Sharon Osbourne turns 73 today and Tony Shalhoub turns 72. Imagine, John Lennon was born this day in 1940.

Christopher Crooks, CFA®, CFP® 610-260-2219