A Delicate Balance: Investing for the Future Amid Economic Uncertainty

Despite the continued resilience of both the economy and the markets in 2025, fundamental questions continue to linger beneath the surface. The economic landscape has been marked by continued overall growth but with increasing bifurcation among consumers, industries and companies alike. Despite this continued positive economic growth, the labor market has increasingly provided a contrasting signal of growing weakness. Throw in the fact that inflation has remained stuck near 3 percent—nearly the exact same level it was as we entered 2025—and significant uncertainty remains as we exit 2025 and push into 2026.

Similarly to the economy, equity markets have remained resilient and pushed markedly higher in 2025. But questions remain over the sustainability of this year’s robust gains given the bifurcation and narrowness of the advance. Most notably and germane to both the economic and market outlook is the sustainability of the artificial intelligence (AI) boom, which has increasingly propelled both the economy and the markets over the past years. As we exit 2025, investors are pondering the often discussed question of whether there is an AI bubble in markets similar to that of the 1999 dot-com era. While this concern has garnered heightened attention and piqued investor fears in recent months, we believe the answer to how you should navigate uncertainty is the same now as it as was back then: maintaining a laser focus on the fundamentals of diversification with an intermediate to long term focus.

Economic Growth

Despite the post-“Liberation Day” tariff angst and recent government shutdown, overall economic growth continues pushing forward in 2025, albeit with an increasing reliance on the AI boom. While current data has been delayed from the government shutdown, the first half of 2025 saw 1.6 percent overall real economic growth, with current estimates from the Atlanta Fed GDP Now tracker checking in at 3.5 percent for the third quarter. Importantly, estimates place AI-related investments as responsible for over 50 percent to as much as 90 percent of overall U.S. economic growth during the first half of this year.

This AI dependence helps bring to light the increasing bifurcation and delicate balance upon which the U.S. economy rests. Most notable are the growing questions about the stark contrasts in consumer experiences based upon age, income and asset levels. Lower-income and younger consumers are facing mounting challenges as evidenced by rising delinquency rates. According to the recently released New York Fed Consumer Credit Panel, overall household debt increased by 1 percent in the third quarter of this year to $18.6 trillion. Aggregate delinquency rates reached a rising but still manageable 4.5 percent, up from 4.4 percent the previous quarter and the highest level seen since the second quarter of 2020. However, transitions into serious delinquencies have spiked over the past year for those in the lower age brackets, with late payments for those aged 18–29 rising from 2.4 percent in Q3 2024 to 4.95 percent in Q3 2025 and those aged 30–39 spiking from 1.83 to 3.72 percent. This credit deterioration is also apparent for the most high-risk borrowers, with Fitch ratings reporting that the share of subprime borrowers at least 60 days late on their auto loans rose to 6.65 percent—the highest level since 1994.

Contrast that with higher-income consumers, who continue to experience a wealth effect from their rising home prices and stock market investments. The November University of Michigan sentiment survey captured this growing divergence in sentiment, noting that a majority of those with no stock holdings or those in the bottom tercile of portfolio holdings spontaneously mentioned higher prices as a drag on their personal finances, compared to only around one-third of those with higher stock holdings. Similarly, the preliminary report (released mid-month) noted that the overall consumer sentiment fell across all ages, incomes and political affiliations with the exception of consumers with the largest tercile of stock holdings, who saw an 11 percent increase in sentiment given the strength of the stock market.

However, the final University of Michigan report (released at the end of November) noted that this cohort lost all of the gains from the survey’s preliminary reading, likely as a result of the market pullback in the final two weeks of the month. This reflects the disparities between different consumer groups, where wealthier individuals benefit from market gains while lower-income individuals struggle with debt and continued high prices. In November, the National Association of Realtors announced that the share of first-time home buyers dropped to a record low of 21 percent, while the typical age of these buyers reached a record high of 40 years old versus 33 years old pre-COVID-19. Similarly, Moody’s analytics research noted that the top 10 percent of consumers accounted for a record 49.2 percent of consumer spending in the second quarter, the highest percentage seen in data going back to 1989.

The reality is that the overall economy continues to push forward, albeit in a very bifurcated and narrow manner, supported in part by a wealth effect from appreciating assets: Americans overall have more invested than at any point in history going back to 1945. While this is good from a long-term perspective, it does raise risks than an equity market pullback could have a higher than normal impact on higher-end consumers. Put simply, a weakening economy typically poses risks for markets, but this time it could be the opposite, given that U.S. stock market capitalization is a record 2.3 times larger than the annual output of the U.S. economy.

The Labor Market

Despite continued economic growth, the labor market has shown signs of weakening over the past few months. Over much of the recent past, the labor market has been characterized by what is often referred to as a period of low hiring but also low firing—a delicate balance. Over the past few months, however, it appears to possibly be moving toward lower hiring and perhaps more firing. The delayed release of the Bureau of Economic Analysis’s September jobs report showed that 119,000 jobs were added to non-farm payrolls, which, while above expectations, followed downward revisions in the prior few months. Since the labor market began showing increasing signs of weakness in May, average jobs gains have declined to a still positive 39,000 per month. Importantly, the non-cyclical sector of education and health services, which comprises just 17 percent the total U.S. labor market, has accounted for all of the job growth (and more) with 60,000 positions added per month.

The unemployment rate, calculated from the household report, also has ticked up from 4 percent in January to 4.4 percent, with its net showing job losses of 324,000 since May. This weakness appears to have continued into October and November, according to Automatic Data Processing (ADP), which reported job losses of 32,000 in November after a gain of 47,000 in October. This brings the three-month average of this measure to 4,700 job losses with the six-month average a meager 10,700 added per month.

While initial jobless claims have remained low, data from Challenger Grey and Christmas reveals an increase in job cut announcements that are likely to begin showing up in initial jobless claims in the coming months. During the month of October, U.S. employers announced 153,074 job cuts, the highest level for an October since 2003. While November saw an “improvement” to 71,321 jobs cuts, this level remains elevated compared to prior Novembers. This is only the second time it has surpassed 70,000 since the Great Financial Crisis. This brings the year-to-date total to 1,170,821, up 54 percent from 761,358 announced in the first 11 months of 2024 and the largest number since 2,227,725 job cuts were announced through the COVID-impacted year of 2020 and, before that, 2009.

Not only is firing showing signs of a potential acceleration, but we also see signs of even slower hiring in this report as hiring announcements have slumped to 497,151 through November, down 35 percent from last year’s 761,954 and the lowest year-to-date number since 2010, when we were exiting the Great Recession. This increased labor market weakness is also being corroborated by the University of Michigan consumer sentiment survey; 69 percent of respondents noted that they expect more unemployment in the next year, up from 32 percent last November and the highest level since late 2008 and early 2009, when it was also at 69 percent. In data back to January 1978 this has been bested only by a 72 percent reading in May of 1980. Each time it has been in these levels in the past, the labor market has been weak.

Inflation

While the government shutdown has delayed inflation reports, it appears that overall price pressures remains stuck around 3 percent. The recently delayed release of the September Consumer Price Index (CPI) showed overall and core inflation checking in at 3 percent on a year-over-year basis. The impact from tariffs has shown up modestly in goods inflation, which has risen to 1.5 percent on a year-over-year basis. While this is still low, we note that goods have been an area of disinflation in the U.S. Economy for over the past 30 years. Besides the COVID-impacted years of 2020 to 2023, this is the highest goods inflation observed since June 2011 to May 2012. Indeed, from June 1996 to June 2009, goods inflation never exceeded the current level of 3 percent.

Importantly, we believe that the full impacts from tariffs have yet to be felt by the U.S. economy. A current score of announced tariffs by the Yale Budget Lab shows that overall tariff levels are headed to 16.8 percent, up from 2.3 percent to begin 2025. Given the actions of importers, consumers and companies to pull forward inventory, it is unlikely that we have seen the full impact of tariffs. The November Beige Book, for example, which is prepared in advance of each Fed meeting, noted that widespread input cost pressures in manufacturing and retail largely reflect tariff-induced price hikes, with the amount that was passed onto customers varying.

While there are questions about whether tariffs will cause a one-time increase in prices or a more persistent tailwind to inflation, the reality is that overall inflation appears to be stalling at current levels. While the Supreme Court is expected to rule on the legality of tariffs issued under the International Emergency Economic Powers Act, we note that there are other manners under which the administration can implement tariffs. The growing risk is that price pressures continue to be present, with possible greater pass-through to the consumer.

More concerningly, these pressures also appear to be continuing to leak into the larger services sector. Services inflation remains elevated at 3.5 percent year over year through September, with services excluding shelter prices clocking in at 3.7 percent on an annual basis. This appears to have continued into October and November. The Institute for Supply Management Services Purchasing Managers Index prices registered 70 percent in October, the highest reading since October 2022, before registering a still elevated albeit slightly lower 65 percent in November. A similar release from S&P Global noted that input costs rose at the fastest rate seen over the past three years, driving a reacceleration in selling price inflation.

The Federal Reserve

Against this delicate balance and often confusing data, the Federal Reserve has cut rates three times in 2025 given their growing concerns about the labor market. However, there continues to be a growing chorus of Fed governors who are hesitant to cut rates further in the future as long as inflation remains above their 2 percent target. Even as the Fed decided to cut rates in December, there was remarkable dispersion within its ranks, with the 9–3 vote marking the most divisive result in over six years. Of the three members who voted against the decision, two wanted no cut and one wanted a bigger cut. A review of the U.S. central bank’s infamous dot plot showed that there were six total Federal Open Markets Committee members who penciled in no cut at December’s meeting. As a reminder, there are 12 total regional Fed presidents, but only five of them vote on a rotating basis. We believe this reality shows the delicate balance the Fed is trying to navigate between supporting the labor market and bringing inflation back to 2 percent. Uncertainty about where the economy is headed continues to run high, and the results from the Fed’s most recent meeting reflect its deepening internal divisions.

That could change in the coming months, however, given that President Trump is expected to announce his pick to replace outgoing Chair Jerome Powell in the coming weeks, with Director of the National Economic Council Kevin Hassett currently speculated to be a top contender. Hassett has supported Trump’s call for lower rates in the recent past, and the market believes he will follow through. The question remains how this impacts investors’ beliefs about the U.S. central bank’s independence and commitment to returning inflation back to its 2 percent target.

The bottom line is the Fed is navigating a delicate balance and narrow path between supporting employment and avoiding a possible resurgence of inflation, with higher than normal risks to each side of its dual mandate. This brings about the potential for heightened volatility and policy mistakes that could tip the U.S. economy into contraction if the aforementioned labor market weakness worsens or if we experience a possible bout of future rising inflation.

The Bottom Line

While 2025 has proven eventful, the reality is many of the most pressing questions surrounding the economy and markets are similar to those we posed at the end of 2024. The past few months have been marked by high levels of uncertainty, with the 43-day government shutdown delaying or even canceling certain key economic data. All of these questions remain in flux as we find ourselves at a seemingly crucial point in which the answers could tip this delicate economic and market balance one way or the other. Outcomes range from labor market weakness pushing the economy into a contraction to an economic resurgence with still above-target inflation. In addition to the Fed, investors have also been forced to walk this steep tightrope. The key to investing for uncertainty is diversification, which we believe is incredibly important moving forward. Unfortunately, we continue to worry that investors are being tempted to concentrate in the narrow parts of the market, a trend that has driven stocks higher in the past few years—most notably U.S. Large-Cap stocks, which have been pushed substantially higher on the back of technology securities driven by the AI frenzy.

The Increasing Bubble Chatter

The recent though highly segmented market advance, coupled with historically elevated valuations, has led to many questioning whether markets are in a bubble similar to that of the late 1990s dot-com boom and bust. Are these concerns based in reality? The bad news is that no one knows for certain whether an AI bubble is underway, and we will know the ultimate answer only in hindsight. The good news is that regardless of the answer, there is a clear path to navigating economic uncertainty: returning to the fundamental playbook of diversification—not concentration and excess speculation—while maintaining an intermediate- to long-term investment horizon.

The global AI market was estimated at $279.22 billion in 2024 and is projected to reach $3.45 trillion by 2033, expanding at a compound annual growth rate (CAGR) of 31.5 percent from 2025 to 2033. Unfortunately, lots of money will also likely be lost as the winners from this emerging technology grow and change. With elevated valuations embedded in many of these AI stocks, one must also contemplate that much future growth has possibly already been discounted back into the price of these companies. This is very similar to the late 1990s, when investors had already discounted much of the impact that the internet would have in the coming years. We remind our readers that it took over 17 years for the technology sectors of the S&P 500 to reach new highs after its peak on March 27, 2000, with one of the current Magnificent Seven stocks, Microsoft, experiencing a similar fate despite its continued revenue and earnings growth in the coming decade.

While past performance is no guarantee of future outcomes, the chart below shows the results of a study comparing those who invested across a broad spectrum of global equity markets, similar to our diversified equity allocations today, versus those that chose to concentrate only in certain segments of U.S. equity markets. This study starts by investing $1 million in these different “portfolios” in March of 2000, when the prior dot-com bubble hit its peak, and is updated and rebalanced at the end of each subsequent month.

The three yellow lines represent concentrated segments of the markets where the dot-com bubble was most prominent: U.S. Large-Cap technology stocks in the S&P 500, the tech-heavy NASDAQ composite index and the S&P 500 itself, which in Q3 of 2025 finally surpassed its 1999 previous record weighting to the technology sector. The blue lines represent what we believe to be a prudently diversified global equity portfolio, with the dotted blue line having 42 percent in the S&P 500 (U.S. Large Cap), 11 percent in the S&P 400 (U.S. Mid Cap), 5 percent in the S&P 600 (U.S. Small Cap), 7 percent in the Dow Jones U.S. Real Estate Investment Trust Index, 24 percent in MSCI EAFE Index (International Developed Market Equities) and 11 percent in the MSCI Emerging Market index. The dark blue line simply replaces the market cap-weighted S&P 500 index (35 percent of which is concentrated in technology stocks) with an equal-weighted version of the S&P 500, further removing the concentration in the largest stocks where the top 10 names dominate the weightings (over 40 percent today) of the overall technology sector. As you can see, while all portfolios experienced losses, those that were more diversified experienced fewer losses and outperformed for many years to come.

Put simply, this is a reminder of the age-old adage to not put all your eggs in one basket. No one can time the market, and no one should attempt to time a potential bubble. The reality is that you need stay invested and, most importantly, stay diversified. If you do that, all the questions that are so important right now will merely become historical conversations at office water coolers and holiday parties rather than events that changed your financial future.

Over the past few years, both the economy and markets have narrowed, in many cases with parallels that rhyme with the late 1990s. We continue to believe that the delicate balance in both the economy and markets will give way to a broader advance in the coming years. A review of history shows that both the economy and markets broaden after periods of narrow leadership. Following the dot-com bust, the economy and markets eventually broadened as the benefits of the internet spread from the narrow cohort of companies leading the internet’s inception to those that used it to improve the productivity and efficiency of their workforces.

We anticipate a similar broadening in the coming years as AI and technological advancements permeate the economy in similar manners. While we are optimistic about that ultimate outcome, the road to a market broadening is paved with uncertainty. We continue to pay heed to the overall risks that shape our slight underweight to equities. While we continue to worry that part of the solution for U.S. debt issue will likely be a higher future inflation rate to help inflate away the debt, we believe that in the nearer future, fixed income will provide a hedge against any potential economic downturn. Put simply, we believe it is more likely that tariffs could likely cause slower economic growth and perhaps growing labor market weakness, both of which would likely outweigh inflationary impacts. As a result, we remain slightly overweight to fixed income while underweight in commodities.

Within our equity allocations we continue to focus on valuation given the stark differences between various asset classes. While valuation is a notoriously poor timing tool, it has historically proven over intermediate- to longer-term periods to reward patient investors with excess returns. U.S. equities are trading at the second highest Cyclically Adjusted Price to Earnings ratio since the late 1870s, a condition that at least historically has been a headwind to future equity returns. However, in a positive development for intermediate- to longer-term focused investors, we continue to note unique opportunities within U.S. equities.

Within Large Caps, we continue to position for an eventual broadening of the market and remain positioned with an overweigh to the equal-weighted S&P 500 to minimize the aforementioned concentration risk in the market cap-weighted version, as illustrated by the chart above. We note that the S&P is currently on pace for a third year of near-record narrowness. As of the end of November, only 34 percent of the stocks in the S&P 500 are beating the index, up slightly from 28 percent in 2023 and 32 percent in 2024. As a reminder, these are below the long-term average of 48 percent in data back to 1973 and are tied with 1998 and 1999 for the narrowest years on record.

When it comes to Small- and Mid-Cap stocks, we continue to observe relatively attractive valuations, a trend reminiscent of the early aughts that we believe was marked by a similar tech-heavy economic and market backdrop. Similar to today’s AI-driven advance, those years were defined by a narrow, later-cycle economy that was likely held afloat by the prevailing tech theme of the day. Today, U.S. Small and Mid Caps have underperformed their Large-Cap peers and as a result trade at similar valuation discounts to their Large-Cap peers as they did in late 1999. Even after the past six years of U.S. Large-Cap outperformance, U.S. Small and Mid Caps have returned 9.7 and 9.5 percent annually over the past 25 years, respectively, compared to just 7.7 percent by their Large-Cap peers listed on the S&P 500. For intermediate- to long-term investors, valuation matters.

Additionally, we continue to believe that the coming years will likely see the potential for additional U.S. dollar weakness, which has (at least historically) favored international stocks over domestic stocks. We believe that the current administration aims to keep the U.S. dollar as the reserve currency, only at a lower price. Tying this back to the late 1990s, a similarly expensive dollar driven by foreign inflows into the U.S. economy and markets had driven the dollar to 121 on the dollar index but spent the next seven years faltering to just 72 by mid-2011. It remained the reserve currency, only at a cheaper level, which helped U.S. export competitiveness and conspired to propel international stocks past U.S. counterparts.

U.S. Large Cap

U.S. Large Caps continued to perform well in the fall and through the end of November, supported by two strong consecutive earnings seasons and a resumption in Fed rate cuts. Fundamentals have been improving, with expected earnings in 2026 grinding higher over the last six months to $306 per share, up about 4 percent from estimates as recently as the end of May.

Technology, the largest sector of the S&P 500 at a 35 percent index weight, continues to be the driving force of those positive revisions, with the sector’s 2026 expected earnings up 13.6 percent over that same time period. Hyperscaler datacenter spending is the major driver of technology’s strong earnings growth trajectory, and it has continued to exceed expectations throughout 2025. At the beginning of the year, the expected 2026 capital spend of the five largest hyperscalers was just under $300 billion. Today it is up to over $525 billion, more than 75 percent higher than the expectation at the start of 2025.

Increasingly, some investors are pushing back against the relentless rise in spending dedicated to AI datacenter capacity. As an example, the price of default insurance on hyperscaler Oracle’s five-year corporate bonds have tripled from July levels (from 40 to 120) despite the overall credit-spread environment across the investment-grade landscape remaining stable. Oracle has been aggressive in using debt to finance datacenter expansion, while larger competitors have predominantly been reinvesting their respective strong cash flows. Simply put, using leverage to finance the buildout of AI compute capacity is beginning to meet investor pushback, which could potentially slow the pace of growth for the strongest earnings growth driver of U.S. Large Caps.

Since the Fed began raising rates in 2022, U.S. Large Caps (predominantly Mega-Cap tech companies) have been the dominant and consistent source of earnings growth, as the economy has narrowed amid their substantial outperformance. This strong performance and subsequently elevated concentration in the S&P 500 along with climbing valuations present intermediate-term risks to U.S. Large Caps, especially if AI spending sentiment were to move from the high levels of optimism today to something more balanced or even pessimistic. We continue to have a slight underweight to U.S. Large Caps, preferring cheaper equity exposure in which earnings fundamentals have exhibited promising signs of improvement and more desirable diversification benefits over the intermediate term.

U.S. Mid Caps

We remain positive on U.S. Mid-Cap stocks, driven by an appealing intermediate-term setup: strong earnings momentum, rising mergers and acquisitions activity, and compelling relative valuations. The first quarter’s dip has given way to promising earnings recovery signals, propelling forward estimates upward alongside U.S. Large Caps. Thanks to a robust earnings revision landscape, the recent upswing in fundamentals has erased the drawdown from April’s trade policy announcements and currently sits 4 percent higher than April’s “Liberation Day” levels. As a result, U.S. Mid Caps now present a forward valuation of 15.5x—a significant 28 percent discount compared to U.S. Large Caps

Looking ahead, the sustained strength of earnings revisions will be crucial for U.S. Mid Caps to achieve strong absolute and relative returns. Mid Caps have historically epitomized robust earnings growth, achieving a remarkable 9.3 percent annualized increase over the last three decades and outpacing the 7.2 percent gain exhibited by Large Caps. Despite the recent three-year lull in earnings trends for U.S. Small and Mid Caps, which have lagged due to tighter monetary policy, the future looks promising when considering a potential cyclical recovery as the Fed cuts rates and the longer-run productivity potential of AI delivering outsized benefits to more labor-intensive segments of the U.S. economy such as smaller and mid-sized companies.

U.S. Small Caps

Current macroeconomic and market conditions offer an attractive opportunity for investors to prioritize Small Caps in their portfolios, which are currently trading at a valuation discount compared to Large Caps and nearing historical highs in developed markets. Valuation is a poor near-term catalyst but can serve as a strong intermediate- to long-term indication of strong relative performance potential. Near term, attractive relative earnings growth needs to be the catalyst for market leadership, and encouragingly, that is finally occurring. Since the end of May, next 12 month expected earnings have risen by 12 percent, three percentage points higher than U.S. Large Caps. With the current valuation discount already surpassing historically low levels, further notable multiple compression seems unlikely. This presents an appealing risk/reward scenario when considering the relative cheapness of many Small-Cap stocks juxtaposed by the stronger earnings growth we have seen them demonstrate in recent months.

In the long term, we are optimistic about the potential benefits of AI impacting Small-Cap fundamentals. The main reason for this is AI’s potential to significantly decrease labor intensity, which would positively impact the productivity and margin structure of smaller companies. Studies indicate that small companies are far more labor intensive than Large Caps, generating three times the number of jobs per $1 million of enterprise value than their Large-Cap counterparts, while Mid Caps produce twice the number of jobs. This higher labor intensity, which is a challenge during periods of rising wages, offers relatively more operating leverage potential as AI enhances efficiencies. Simply put, if AI investment had a strong return on investment overall, we would expect the benefits of this technology to disseminate throughout the economy. We remain optimistic about the attractive combination of relative valuation, rising earnings expectations and underappreciated productivity drivers over the intermediate term and remain overweight.

International Developed Markets

Both the eurozone and the Japanese economy continue to push forward despite the U.S. imposition of tariffs. Economic growth in the eurozone continued in the third quarter, rising slightly to 0.2 percent on a quarter-over-quarter basis from 0.1 percent in the second quarter.

This growth looks set to continue in Q4 with the HCOB Eurozone composite continuing its recent strengthening trend, rising to 52.8 in November, driven by strength in the services sector, which reached its highest level since May 2023, while manufacturing pulled back to 49.6 from the prior month’s 50. The unemployment rate remained stable in October at 6.4 percent, just off these cycles and the all-time low (since the block was created) of 6.3 percent, which was last registered in April 2025. Meantime, November inflation readings ticked up slightly to 2.2 percent overall with core inflation at 2.4 percent. After cutting deposit rates by 2 percent over the past year, the European Central Bank (ECB) is expected to remain on hold well into the future. Despite these relatively positive readings, however, ECB President Christine Lagarde noted two-sided risks to the outlook moving forward given the heightened uncertainty around the “volatile global trade policies.”

Over in Asia, Japan’s inflation remains well above the 2 percent target of the Bank of Japan (BOJ), which has been the goal over the past few years. This has provided a backdrop that has shifted wage dynamics in Japan from one where lackluster to negative real wage growth weighed on the economy and provided a fertile ground for deflation to one of positive wage growth. This has supported underlying higher inflation and appears to have ended Japan’s decades-long deflationary spiral. In fact, the Japan Council of Metalworkers, which represents over 2 million manufacturing workers, recently announced a push for a record monthly base pay increase (going back to 1998) in its annual negotiations. This comes on the heels of other Japanese unions announcing intentions to pursue similar large increases to base pay salaries. The movement has raised the potential for a rate increase at the Bank of Japan’s December meeting given that BOJ Governor Kazuo Ueda has repeatedly noted the need to confirm momentum in wage discussions.

The offset to this is the uncertainty of economic impact resulting from tariffs. As of this writing of this article, the market is pricing in an 81 percent chance of a 25 basis point hike to the Japanese policy rate. Japan’s 10-year government bond hit a yield of 1.89 percent, which is just off the post-2000 high of 1.99 set way back in 2006. The last time this instrument was sustainably above 2 percent was pre-1997. Meantime, the 30-year bond hit an all-time record of 3.41 percent in data back to 1999.

We remain cautious in our outlook for both regions amid inflationary pressures and global uncertainties weighing on growth. Much as in the U.S., Europe and Japan’s central banks are navigating a tight balance between inflation and economic recovery. However, we believe the U.S. is likely to ease rates, while these central banks appear to be on hold or poised to raise in the nearer term. Overall, we believe these markets have attractive relative valuations and are set to possibly benefit from renewed investor interest. They could even potentially gain from repatriation of investment dollars from the U.S. toward their domestic economies and markets. Importantly, we highlight our prior comments on the Trump administration’s likely goal to cheapen the U.S. dollar, which from a purchasing power parity perspective is expensive relative to the euro and the yen. We note that—at least historically—when foreign currencies have appreciated relative to the dollar, international stocks have outperformed U.S. equities, especially in dollar terms.

While we maintain a relatively positive long-term outlook toward these markets, our positioning remains neutral relative to our benchmark given the tariff uncertainty and our overall desire to maintain a somewhat cautious outlook.

Emerging Markets

Emerging-market equities were among the top-performing asset classes in 2025. Propelling these gains were renewed interest in Chinese equities stemming from an AI-driven rally in equity markets, a de-escalation of the U.S.-China trade war, potential for more fiscal stimulus from Beijing and the weakening of the U.S. dollar, which benefits emerging-market assets in general—particularly for dollar-based investors. On October 30, the U.S. and China struck a new trade truce after talks between Trump and Chinese President Xi Jinping. Washington agreed to cut tariffs in exchange for Beijing cracking down on the illicit fentanyl trade, resuming U.S. soybean purchases and pausing controls on exports of rare earth metals. Markets reacted positively, and year to date (at the time of this writing), the MSCI China index was up more than 31.4 percent, while the broad MSCI EM Index was up over 30.8 percent.

Foreign investment inflows have recently returned, as investors continue to anticipate rate cuts in the U.S. search for new ways to play the AI story and find more attractively valued equities and add to non-dollar assets. The on-and-off nature of tariffs combined with worries over an ever-increasing U.S. deficit have led to more flows to emerging and international developed markets. However, this is counterbalanced by ongoing geopolitical risks between the U.S. and China and increasing levels of Chinese debt coupled with poor demographics and tariff uncertainty. These risks remain as short- and longer-term challenges for the Chinese economy.

The probability of more Fed policy easing in coming months has risen and has implications for the dollar and investments in developing markets. Rate cuts in the U.S. and the increased possibility of dollar weakness may lead to reduced debt burdens for emerging-market governments and boost exports. Additionally, a Fed easing cycle could allow for an easing of local monetary policy in developing countries, providing economic stimulus at the local level. Ultimately, the level of interest rates in the U.S. along with tariffs will likely shape the relative strength of the U.S. dollar versus emerging-market currencies. This is something we continue to watch closely. Regardless of the strength or weakness of currencies, the impact of currency on returns and portfolio diversification in general is something that we feel is underappreciated, as dollar strength has persisted in recent years. This may not always be the case, and we believe it is a reason to have exposure to the international developed and emerging-market asset classes.

The diverse nature of the emerging-market asset class has dramatically shifted over the past 20 years, with technology and financials now being the two largest sectors. GDP growth is expected to be higher, and relative valuations versus the developed world, even with this year’s run-up, continue to sit at relatively cheap levels. Demographics in some developing economies (e.g., India) are very favorable as well. Given this, we believe it is important to have long-term exposure to emerging markets in a well-diversified portfolio. However, given the continued economic risk of tariffs and geopolitical risk tied to China, we continue to modestly underweight the asset class.

Despite seemingly sticky inflation and tariff and inflation worries, U.S. investment-grade bonds have provided solid returns in 2025, with the Bloomberg Aggregate Bond index rising over 7 percent year to date. Yields have declined across the interest rate curve, with the two-year Treasury falling from 4.24 percent to start the year to its current level of 3.54 percent as the Fed cut rates three times this year. Unlike in 2024, when the Fed cut rates and intermediate- to long-term Treasury yields moved higher, this time the market has “agreed” with the Fed and similarly pushed five-, 10- and 30-year yields lower. After starting the year at 4.57 percent and pushing to a high of 4.79 percent in mid-January, 10-year yields pushed lower post- “Liberation Day.” After spiking back to 4.6 percent in May, 10-year yields have once again subsided to around 4.18 percent as of this writing.

While we acknowledge inflation risk and believe it is a longer-term phenomenon, we have forecasted that the greater risk in the nearer term is slower economic growth. As a result, we have opted to overweight fixed income and extend the duration of our portfolios. Consistent with our forecast, over the past few months both two- and five-year inflation swaps and break-evens have pushed lower.

While this outlook has shaped our positioning over the past year, we note a likelihood that our forecast could evolve in the future given the pressure the administration has placed upon the Fed to cut interest rates. With the president likely to nominate Hassett to the post of Fed chair in early 2026, investors have expressed unease that he will cut rates aggressively to please President Trump. The Financial Times recently reported that members of the Treasury Borrowing Advisory Committee expressed these concerns to the Treasury Department in November. If he is nominated, financial markets will be watching his actions intently to gauge his commitment to keeping the Fed independent versus prioritizing appeasing the administration’s desire for lower rates. We also remind readers that the Supreme Court is expected to rule on the legality of tariffs in December, which could cause heightened volatility in the coming months, as government tariff revenue may have to be rebated if they are deemed unconstitutional.

Regardless of that ruling, we believe it is likely that tariffs are here to stay given other legal avenues for the administration to apply them. The debate of who pays the tariffs is important, but the reality is they are currently helping to “pay for” the One Big Beautiful Bill Act. Even the Congressional Budget Office in its scoring of Trump administration’s latest budget reconciliation bill stated that a combination of higher deficits and increased interest rates could conspire to push annual interest costs as a percentage of annual U.S. economic growth to 4–5 percent. This is important given that this range likely touches the potential upper bound of U.S. economic growth, meaning that the U.S. could be borrowing to simply pay its interest costs.

While we are concerned about the intermediate- to long-term implications of the current U.S. fiscal situation and potential for inflation, we continue to believe that U.S. Treasurys could offer a port in the storm if an economic slowdown were to occur. In the absence of a persistent near-term inflationary spiral caused by tariffs, we believe that the real rate compensation on Treasurys currently compensates investors who take on increasing risks.

We remain overweight to fixed income in our portfolios, with a focus on quality and a slightly overweight duration relative to the Bloomberg Aggregate Index. While we do not expect interest rates to slip back toward the low levels exhibited in the last economic cycle, we believe that fixed income has likely returned to its roots as an income-generation vehicle that can also provide risk mitigation against falling equity prices amid slowing economic growth. While inflation remains an ever-present worry, we continue to focus on an allocation to commodities within our portfolios as the best manner in which to hedge that potential risk.

Duration

Longer-term bonds play an important role in building diversified portfolios. However, it is important to note that we cannot completely isolate duration; rather, it often comes in the form of government agency bonds, municipal debt and corporate bonds, which not only move with interest rates but also often layer in credit and liquidity risks. This is where we are focused on “risk-free” duration, meaning Treasurys. Risk-free duration (free of any other risk than purely its sensitivity to interest rate movements) is possibly the only metric in the investible universe that does not have some credit associated with it. This is vital to well-diversified portfolios over the long term, as the expansion and contraction of credit is highly cyclical. When credit conditions change, everything else aside from Treasurys will be affected, if even modestly. Even the highest credit quality instrument has the risk of bankruptcy or impairment in the distribution of potential outcomes.

The bond market interest rate curve continues to be inverted up to maturities of inside four years, foretelling the market’s current belief that rates will push lower over the foreseeable future. Pick your rationale behind this, but we believe it is telling that investors are willing to forgo some expected return away from Treasurys to yield less over a four-year period than they would in money markets. If signs of stress grow in the credit markets, we believe that extra duration will benefit our portfolios. We continue to maintain a modest overweight to duration with a focus on high-quality fixed income to diversify the growing risks in credit and other risk assets.

Government Bonds/TIPS

U.S. fixed income is in a very investible spot, and U.S. Treasurys are no exception. Beyond five years, the curve is continuing to look very attractive for nearer- to intermediate-term focused investors. With U.S. rates (both nominal and real) being some of the most elevated in the world, the U.S. bond market is currently relatively attractive. Not only is the Fed being pressed into being accommodative, but the curve has term structure priced into it beyond five years. The risk going forward for investors remains the path of future inflation. Treasury Inflation-Protection Securities (TIPs) break-evens are currently around 2.6 percent in the next year and 2.2 to 2.3 percent out to 10 years. Given our current forecast we continue to favor nominal Treasury bonds over TIPs but continue to evaluate the future inflation backdrop on an ongoing basis.

Credit

Aside from the hiccups in February and March, credit has been consistently tightened over the course of 2025 but could be showing signs of stopping or even reversing. This coincides with a bit more volatility in the equity markets, which only reinforces our belief that extra duration will benefit investors in the long run. With some widening, investment-grade credit is an OK way to express some modest excess duration. We continue to avoid high-yield bonds given their continually tight spreads and maintain our focus on higher-quality credit to add yield to portfolios.

Municipal Bonds

The underperformance in municipal bonds this year still does not offset the outperformance of the asset class in 2022, when Treasury rates rose dramatically. There can be a number of reasons for the underperformance, but the vast majority of them will fall under a few categories. First, municipal bonds were relatively rich on a historical basis compared to taxable bonds following the extreme rate increase of 2022, which harmed taxable bonds relative to municipals. Secondly, the change in administration has created heightened potential for tax reform as well as a need for increased government revenues. While high-grade municipals are still positive on the year, we continue to carefully monitor underperformance while also remaining opportunistic.

We believe real assets play an integral role in building diversified portfolios due to their lower correlation to traditional equities and fixed income. Real assets can provide valuable hedges to unexpected inflation and a strong sensitivity to real interest rates—important considerations when it comes to constructing resilient portfolios over an intermediate- to long-term period. Years 2021 and 2022 provided a lens into the value of this diversification with the standout performance of commodities in response to rising inflationary pressures and Russia’s invasion of Ukraine.

Conversely, the sharp decline in real interest rates from 2010–2012 and generally through 2022 provided a fertile backdrop for eye-popping performance of real estate investment trusts (REITS). Put simply, sharp changes on the inflation and real interest rate fronts are very difficult to call correctly from a timing perspective, underlining the rationale for a structural allocation to real assets.

For much of the past 25 years (excluding 2022), many of the risks that have existed in the global economy have been toward tumbling into a period of deflation. This is where fixed income has previously proven to be an effective hedge against most economic and market downturns. However, both sides of the distribution are seemingly now in play, as inflation has remained elevated over the past years. This is the narrow path that policymakers are attempting to navigate, with heightened risks on each side of the equations. Tariffs, de-globalization, heightened levels of debt and growing questions of Fed independence only serve to increase those risks going forward. Given the heightened level of uncertainties that exist, we believe that real assets play an increasingly important role in hedging market risks.

We continue to recommend the inclusion of real assets and maintain our exposure to commodities. However, given our forecast that an economic slowdown is more likely than an inflationary spiral in the near term, we currently retain an underweight position in commodities to fund an overweight position to fixed income. Given our desire to take slightly less overall equity market-like risk and the reality that REITs have possessed weaker fundamentals over the recent past, we currently remain underweight to this asset class.

Real Estate

REITs remain highly sensitive to overall changes in real interest rates and economic conditions. This is likely because changes in real rates impact real estate more than any other asset class in our portfolios, especially when overall REIT fundamentals remain somewhat weak. In fact, REITs have been a laggard this year as changing demographics, economic trends, interest rate movements, and affordability issues continue to cloud the outlook. Given our desire to take slightly less overall equity market-like risks and that REITs have possessed weaker fundamentals, we remain underweight in these vehicles. This is based on our analysis of not only the fundamentals and market structure of the asset class but also the uncertainty surrounding interest rates, tariffs, trade policy and inflation.

Real estate prices are influenced by several factors, not the least of which hinges on the anticipated trajectory of real long-term interest rates. In addition, REITs have maintained a positive correlation with fixed income for nearly as long as we have held our dynamic underweight. The past year has been no exception; real estate prices typically have a direct inverse relationship with financing costs tied to buying an existing property or beginning a new project. Consequently, the aggressive cycle of rate hikes had adverse effects on longer-duration assets, including REITs. This is in stark contrast to the relatively favorable period for real estate prices during the ultra-low interest rate environment seen shortly after the onset of COVID. Even though the market expects the Fed to lower interest rates in coming quarters, real estate projects are financed with much longer-dated borrowing. While short-term interest rates move according to the direction in which the Federal Open Market Committee dictates, intermediate- to longer-term rates remain a function of supply, demand, growth and inflation expectations, as well as term premium. They also currently fall outside of the Fed’s direct control.

While we are seeing some signs of improvement in select areas of REITs, the few positive signals that we are witnessing are not evenly distributed among the various real estate sectors, and it may take some time for this asset class to normalize. Additionally, in keeping with our analysis of other areas of the market, we have noticed a bifurcated real estate market in which top-tier properties and projects receive substantial interest and demand while much of what is not a top-tier property is left to languish. As many potential bright spots appear in the world of real estate, a host of potential new headwinds also arise.

Indeed, the resiliency of the U.S. economy over the past year has supported stronger than expected net operating income growth, as the general positive correlation between positive GDP growth and REIT performance has held up. We find it encouraging that, broadly speaking, REITs have reduced leverage in recent years. And despite sharply rising interest rates, certain REIT sectors—including data centers, health care facilities and cell towers—have demonstrated steady signs of rental growth above inflation. In addition, there may be a renewed focus on the part of policymakers to prioritize housing affordability as we turn the calendar into a mid-term election year. This would likely involve measures to counteract high financing costs, but we hesitate to draw too many conclusions at such an early stage in the process.

On the other hand, we must consider that increasing macroeconomic uncertainty will drive expectations about interest rates, volatility, economic growth and other factors likely to drive REIT performance. Inflation has remained above the Fed’s target, and while broad measures of inflation have been trending downward, recent readings have revealed signs that we are not out of the woods quite yet. The Fed may be somewhat constrained in cutting rates further if inflation remains above target, and more rate volatility could be on the way given recent trends in long-term inflation expectations, adjustments in U.S. trade policy, fiscal deficit challenges and unemployment.

We find this to be an asset class worth watching, and we continue to evaluate our positioning on an ongoing basis. While the income-generating power of real estate can also be a compelling reason to own REITs, we must weigh the longer-duration nature of this asset class against other positions currently held in our portfolio (like long-term Treasurys) that may provide a negative correlation to equities if risks to economic growth materialize. As such, we continue to maintain our slight underweight positioning to this asset class.

Commodities

Commodities have posted strong gains this year, largely due to surging gold prices. Commodities in energy, such as oil and natural gas, have declined modestly. The asset class experienced some volatility earlier in the year, falling in April amid trade and tariff concerns. As the year progressed, an easing and extending of the tariff policies alleviated some of those concerns, and commodities prices bounced back. Commodities are up approximately 16.8 percent so far this year. A weaker dollar has also been beneficial to the asset class.

A notable part of the commodity gains this year are attributable to gold, which is not as sensitive to economic growth concerns but is viewed as an inflationary hedge. Gold continues to remain near all-time highs and is up over 60 percent year to date. Factors driving higher gold prices include global investors looking to reduce their exposure to U.S. dollar assets, ongoing purchases by global central banks and a spike in domestic buyers of gold ETFs. A trend toward higher gold investment suggests investors are looking to hedge against higher future inflation levels and a weaker U.S. dollar.

Weakness was generally confined to the energy sector, which is more sensitive to global growth concerns and the impact of newly announced tariff and trade policies. Rising global trade tensions, particularly between the U.S. and China, fueled recession fears and rattled markets.

Aside from precious metals, commodity prices have been mixed. Energy prices (including oil) are down this year but have mostly rebounded off April lows. A meaningfully higher upside to oil prices is somewhat limited, however. An announced Organization of the Petroleum Exporting Countries (OPEC+) policy shift to ramp up production faster and on a larger scale than previously anticipated has increased spare production capacity, and U.S. shale producers can also ramp up output in response to higher prices. Industrial metals such as nickel, copper and aluminum have advanced, particularly over the short term given slightly higher overseas demand. Agricultural goods have been relatively flat on good production levels and excellent weather, although livestock prices, especially beef, have risen significantly. Coffee prices also remain elevated.

Going forward, primary catalysts for higher commodity prices are the reemergence of demand from China, continued higher inflation expectations, and further weakening of the U.S. dollar. In energy, persistent underinvestment, a pivot back to OPEC+ production cuts and a reduction in U.S. production could add additional price pressure. Market expectations for inflation have fallen over time but remain embedded in market expectations, which is a plus for commodities.

We remain underweight the commodity asset class, preferring fixed income and economically sensitive asset classes like Small- and Mid-Cap U.S. stocks. Our outlook for commodities is modestly positive, driven by the current economic and political uncertainty. Overall, we continue to believe the commodity asset class retains positive return expectations and significant diversification benefits.

The opinions expressed are those of Northwestern Mutual Wealth Management Company as of the date stated on this material and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute individual investor advice and is not intended as an endorsement of any specific investment or security. Information and opinions are derived from proprietary and non-proprietary sources.

Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company (NM), Milwaukee, WI, and its subsidiaries. Investment brokerage services are offered through Northwestern Mutual Investment Services, LLC (NMIS), a subsidiary of NM, broker-dealer, registered investment adviser, and member FINRA and SIPC. Investment advisory and trust services are offered through Northwestern Mutual Wealth Management Company® (NMWMC), Milwaukee, WI, a subsidiary of NM and a federal savings bank. Products and services referenced are offered and sold only by appropriately appointed and licensed entities and financial advisors and professionals. Not all products and services are available in all states. Not all Northwestern Mutual representatives are advisors. Only those representatives with “Advisor” in their title or who otherwise disclose their status as an advisor of NMWMC are credentialed as NMWMC representatives to provide investment advisory services.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss.

Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market.

With fixed income securities and bonds, when interest rates rise, bond prices usually fall because an investor may earn a higher yield with another bond. Moreover, the longer the maturity of a bond, the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. At maturity, the issuer of the bond is obligated to return the principal (original investment) to the investor. High-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase and reverse repurchase transaction risk.

Investing in special sectors, such as real estate, can be subject to different and greater risks than more diversified investing and may present more financial and other risks than investing in companies of larger capitalizations and more seasoned companies. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks to real estate investments.

Investing in real estate companies entails some of the risks associated with investing in real estate directly, including sensitivity to general and local economic and market conditions, demographic patterns, changes in interest rates and governmental actions.

Investors should be aware of the risks of investments in foreign securities, particularly investments in securities of companies in developing nations. These include the risks of currency fluctuation, of political and economic instability and of less well-developed government supervision and regulation of business and industry practices, as well as differences in accounting standards.

Commodity prices fluctuate more than other asset prices, with the potential for large losses, and may be affected by market events, weather, regulatory or political developments, worldwide competition and economic conditions. Investment can be made directly in physical assets or commodity-linked derivative instruments, such as commodity swap agreements or futures contracts.

Treasury Inflation-Protected Securities (TIPS) are securities indexed to inflation in order to protect investors from the negative effects of inflation.

The U.S. Large Cap asset class is measured by the S&P 500 Index, which is a capitalization weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The gross domestic product (GDP) is the amount of goods and services produced in a year in a country.

The U.S. Mid Cap asset class is measured by the S&P MidCap 400 Index, which is the most widely used index for mid-sized companies and covers approximately 7 percent of the U.S. equities market.

The U.S. Small Cap asset class is measured by the S&P Small Cap 600 Index, a market value weighted index that consists of 600 small cap U.S. stocks chosen for market size, liquidity and industry group representation.

The International Developed Markets asset class is measured by the Morgan Stanley Capital International Europe, Australasia, and Far East (MSCI EAFE) Index, which is composed of all the publicly traded stocks in developed non-U.S. markets. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The International Emerging Markets asset class is measured by the MSCI Emerging Markets Index, which is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging-market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey.

The Real Estate asset class is measured by the Dow Jones U.S. Select REIT Index, which intends to measure the performance of publicly traded REITs and REIT-like securities. The index is a subset of the Dow Jones U.S. Select Real Estate Securities Index (RESI), which represents equity real estate investment trusts (REITs), and real estate operating companies (REOCs) traded in the U.S. The indices are designed to serve as proxies for direct real estate investment, in part by excluding companies whose performance may be driven by factors other than the value of real estate.

The Commodities asset class is measured by the Bloomberg Commodity Index (BCOM), formerly the Dow Jones-UBS Commodity Index, which is a highly liquid, diversified and transparent benchmark for the global commodities market. It is calculated on an excess return basis and reflects commodity futures price movements.

The Consumer Price Index (CPI) examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

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