The Markets Are Walking a Tightrope. How Can Investors Find Their Footing?

**Susan Dziubinski: **Hello, and welcome to Morningstar’s fourth-quarter 2025 US stock market outlook. My name is Susan Dziubinski, and I’m an investment specialist with Morningstar and co-host of The Morning Filter podcast. So we head into the final quarter of the year. Stocks are hitting new highs. The AI trade is not just alive and well—it’s fueling much of the market’s gains. Investors seem unconcerned about negative macroeconomic headwinds and inflationary pressures. So will the good times last?

Here to share their outlooks for the stock market and the economy for the rest of the year are Morningstar Chief US Market Strategist Dave Sekera and Morningstar Chief US Economist Preston Caldwell. And this quarter we’re also joined by Morningstar Asia equity strategist Kai Wang. So let’s begin. Dave, over to you.

**David Sekera: **All right, thank you, Susan. Good afternoon, everybody, and welcome to our fourth-quarter outlook. As always, I’ll just provide a quick overview of the US equity market valuation, review our sector valuations and a couple of top picks from our equity analyst team. We’ll review valuation by economic moat and then talk about mega-caps, because of course, that’s what’s running the markets these days. And then I’ll turn it over to Preston, who will provide his US economic outlook. As Susan mentioned, we have a special guest star coming from Hong Kong today, Kai, who’s going to give his overview for the Asia markets. And then I’ll just wrap things up with a very quick fixed-income outlook and then we’ll take as many questions as we can. So let’s go ahead and jump into it.

So as of the end of the third quarter on Sept. 30, the US equity market was trading at a price/fair value of 1.03. So essentially a 3% premium to our fair value. So for those of you that aren’t familiar with how we take a look at equity market valuation, we look at it a lot differently than what you’re going to hear from a lot of other market strategists. A lot of other market strategists always seem to come at it with a top-down perspective. They’ll have some sort of formula or algorithm to come up with whatever they think S&P 500 earnings for the year is going to be. They apply a forward multiple to it, and it seems like they always tell you that the market’s 8% to 10% undervalued. In my mind, that always seemed to be much more of an exercise in goal-seeking than truly a true valuation. We cover over 1,600 companies globally, of which over 700 of those are stocks that trade on US exchanges. So what we do is we take a composite of the market capitalization of those over 700 companies, and we’ll divide that by a composite of the intrinsic valuations of those companies as determined by our equity analyst team. So in my mind, that is really truly a bottoms-up focused analysis of market valuation.

And I would just note that when we talk about the market being overvalued or undervalued, we’re looking at it compared to the intrinsic valuations, which of course are going to be determined by the cost of equity as used in our discounted cash flow model. So if the market were trading exactly at fair value, that would mean that, over time, for long-term investors, we’d expect that the market would appreciate at a rate of return pretty much equal to that cost of equity, less the dividend yield. Whereas if it’s undervalued, we see a discount to that fair value. So over time you would see that discount fade away as the market caught up to our valuations. And in this case, at that 3% premium, we’d expect that the market over the next couple of years probably earns a little bit less than that cost of equity.

Now, when we break this up, we take a look at it by category and by capitalization. At this point in time, by category, value stocks—still undervalued, trading at a 3% discount to fair value. Core stocks, trading at a 4% premium. So that would be the upper end of the range that I consider to still be within fair value. Typically, we have like a 5% plus or minus range. They consider something within fair value range. And then growth stocks at a 12% premium. I just note at that 12% premium, the growth category since 2010 has only traded at that much of a premium or more only 5% of the time. So pretty rare territory that we see it in that area.

Taking a look by capitalization, large-cap stocks also at the top of the range that we consider to be fairly valued at a 4% premium. Mid-cap stocks, pretty close to fair value. And small-cap stocks, still being undervalued at that 16% discount to fair value. So how have our fair values worked out over time? Just taking a look where they are right now, at that 3% premium, certainly not unprecedented. We’ve been here in the past, we’ve seen a couple of instances where the market has traded a higher premium. But pretty rarely do we have this much of a premium. We actually were about this much of a premium coming into the year.

That was, of course, before DeepSeek hit the headlines and sent the market reeling and of course also before the Trump tariffs and trade negotiations at the same point in time. That had pushed the price/fair value of the market all the way down to a 17% discount in early April. That was the point in time we actually had moved to an overweight recommendation in the equity market. Once we moved back up closer to fair value, we’d moved back to a market weight, which is still how we would recommend investors weight the market in their equity allocations today is at that market weight. So even though we are a little bit above fair value, I think today it’s more important to be positioned correctly in the marketplace than I think it is to try and trade the market as far as being slightly overvalued at this point.

Now, the title for our quarterly outlook: “No Margin for Error.” And so when we’re looking at the market today and thinking about the market going forward over the next year or so, I really think the market is walking a tightrope. So on the one hand, we have the AI buildout boom and monetary easing. We’re seeing tens, hundreds of billions of dollars being spent on building out artificial intelligence. Whether it’s the hyperscalers or it’s all the data centers, all the infrastructure and the energy that needs to be built out to be able to support the future growth there. However, that’s only slightly outpacing what we’re seeing going on in the economy. So we still see a lot of negative macroeconomic headwinds. Preston will give his view for the economy for the next couple quarters and the next couple years as well as we still see inflationary pressures yet to come later this year and into next year as well. So it’s really a balancing act between those two different forces.

Q4 2025 Stock Market Outlook: No Margin for Error

The market is walking a tightrope between an AI boom and an economic slowdown.

Today, as far as artificial intelligence goes, it still seems like we’re in the stage where it’s increasing at still an increasing rate. When I look at our fair values, I’d note that over the course of the third quarter, most of those stocks that we cover that are leveraged to artificial intelligence, we continue to raise our valuations there. Now, we did see the market go up slightly faster than we’ve increased some of our valuations. But I’d note for the most part, other than Microsoft MSFT, almost all of those AI stocks are at least fairly valued or fully valued. And in many cases you’re getting to be overvalued as well. And as we’ve talked about before, and this still continues to increase even further, almost 40% of the market is concentrated in just those 10 stocks. So even if you’re a well-diversified investor across many different types of indices, for example, the Morningstar US Market Index, you’re still going to be very heavily skewed toward those top 10 stocks because they do account for such a large percentage of the market capitalization of the total market.

And then lastly, of course, we have the ongoing trade negotiations and the tariffs. In my mind, that’s still a wild card yet to be played out. I think we’ll see in the next couple of weeks what those negotiations will bring with Mexico and then of course in November what those negotiations will bring with China. So still a couple of wildcards that, depending on how they work out, could be positive or negative for the marketplace. Taking a look at the returns in the third quarter, really a very strong quarter, up almost 8.1%. It was really driven by the core category.

I just note that within that core category, that return was heavily concentrated in Apple AAPL stock. Apple stock came into the year as a 2-star-rated stock. It was actually a detractor to the market for the first half of the year as that stock fell over the first six months, caught a bid once it hit 3-star territory and is moved back up into 2-star territory once again. And then Alphabet GOOGL being the other core stock that was really a big winner here in the third quarter, I think that was up like maybe 38% just this quarter alone. So between those two stocks, that’s over 50% of that return this past quarter in the core category.

Taking a look at growth stocks, a quarter of that return came from just Nvidia NVDA in and of itself. And then if you were to add, Tesla TSLA, Broadcom AVGO, and Microsoft to that, those four stocks account for over 55% of that return. The value category, however, was broadly diversified across the stock coverage there. So we didn’t see any individual company that really led to a skewing of those overall returns. Looking at stocks by capitalization, the large-cap stocks up the most. I’d just note that within the large-cap space, five different stocks there accounted for over 70% of the return. Most of those stocks in our view have probably played themselves out at this point in time. And then small-cap stocks tried to do well. They tried to outperform. They actually had outperformed pretty well in August. But then once September came rolling along, and we saw a lot of these different transactions being announced with the AI stocks, everyone ratcheted their valuations back up on those stocks and brought that large-cap category up once again.

So taking a look at it for the year, you’re just looking at growth, value, core. A couple of different comments here on just how concentrated those are. Same with large, mid, and small. But I think getting into it, it’s much more interesting to look at just how much the market has moved, how volatile of a year it has been coming into the year at a slight premium. Of course, we then had the trade and tariff negotiations, we had DeepSeek hit the headlines. And I think that’s just a good indicator for equity investors that you have to be prepared for these types of drawdowns. Artificial intelligence is still going great guns today, still has an impressive future track record for just how much it’s expected to grow. But any kind of potential hiccups in AI certainly could send valuations there reeling once again. And then, of course, just how quickly of a recovery you’ve had back in the marketplace.

Getting back to that slight premium once again. Taking a look at returns by sector for the third quarter, communications being the leader. But I would also note there that really was driven by the return that we saw in Alphabet. That’s been a stock that we’ve been very constructive on for quite a while. Had been a 5-star stock not that long ago, had been a 4-star-rated stock I think for much of this year. Finally the market seems to agree now with our valuation. It’s now moved into 3-star territory now that it’s moved up 38% last quarter. If you take a look at the tech sector, Apple, Nvidia, Broadcom, those three stocks alone are almost 60% of that sector gain this past quarter.

Now consumer cyclical, I have to point out, while it had a very good return from that sector perspective, is pretty much all about Tesla. So Tesla has now moved well up into overvalued territory, rose over 40% this past quarter. That’s 75% of the consumer cyclical return accounted for in just that one stock. As a 1-star-rated stock, it’s really kind of morphed into now being an AI play than, or at least the market is considering it as an AI play as opposed to an electric vehicle and robotaxi company. Some of the laggards, just looking at real estate and financials, we’ll talk a little bit about our valuations there. Bit of a tale of two cities, but real estate and financials both should benefit from easing monetary policy, real estate being undervalued, whereas we think financials have already played out and is overvalued. Healthcare—a lot of regulatory scrutiny, a lot of issues with reimbursement rates, potentially lowering reimbursement rates. So we’ve seen a lot of pressure in that sector. And then the consumer defensive sector, really the only sector that saw a loss last quarter. I’d note this was pretty broad-based. If you look at the top 10 stocks by market cap within the sector, seven of those pulled back and of course, as we’ve talked about in the past, Walmart WMT and Costco COST, two stocks that are very large within the category, both of them probably 1-star-rated stocks if not 2-star-rated stocks, being significantly overvalued in our mind. Looking at returns year to date, some more commentary here.

I’m just going to kind of move on because I want to make sure we have enough time for Preston and Kai. Taking a quick look at the attribution analysis, I would just note that the returns from the first half of the year have broadened out in the third quarter. So the top 10 only accounted for 53% of the overall market return in the quarter versus 74% in the first half of 2025. I’d also note that seven of these top 10 stocks are all in some way, shape, or form tied to the AI buildout boom. So very concentrated market in AI. JP Morgan JPM the only value stock that made the top 10 list here, and then I just want to highlight, too, coming into the year a number of these, I think four of them, it looks like, were rated 4 stars at the beginning of the year. With as much as they’ve run at this point in time, Microsoft being the last of these that’s still rated 4 stars that we think is undervalued, and in fact, when I take a look at our AI plays and I take a look at the large-cap space overall, one of the few stocks tied to AI and one of the few large-cap stocks that we still see a lot of value for investors today.

Taking a quick look at the detractors year to date, I’m sorry—for the quarter—really no significant detractors. UnitedHealthcare UNH, of course, that stock has been under a lot of pressure with reimbursements and excess costs this year, but again, when you look at it overall, really no individual stock. I would just note that there does seem to be a theme here. A number of these different companies the market is considering to be at risk in their business models from being disrupted by artificial intelligence. So stocks like Salesforce CRM, Accenture ACN, Fiserv FI, Adobe ADBE, Trade Desk TTD, ServiceNow NOW, all companies the market at this point in time has been selling those off because of those concerns.

Looking at these by rating, a number of these were 1-star- and 2-star-rated stocks at the beginning of the year, with as much as they’ve sold off. There’s no 2-star or 1-star stocks left, in effect, and most of these now are 4-star-rated stocks. A couple of 3, and Fiserv now edging into 5-star territory. I’ve shown this chart in our past, so just providing kind of this update on value stocks, how they trade compared to the broad overall market. So’s still trading at a pretty good discount compared to that broad market valuation. So still attractive on a relative valuation basis, even though at a 3% discount, it’s not necessarily that great of a margin of safety. And then small-cap stocks still trading somewhere close to some of the most undervalued levels that we’ve seen going all the way back to 2010. So in our view, when we look at the small-cap space, I would look at this one as being undervalued on both an absolute-valuation basis as well as a relative-valuation basis.

Just taking a look at our star ratings by percentage overall as well as each individual sector, I would just note it just keeps getting harder and harder to find undervalued stocks, very small percentage on a historical basis that are in that 4- and 5-star territory overall by market. And of course those sectors that we think are undervalued is where you’ll see the higher percentage on a number basis. New chart that we brought to you this quarter just shows a tree map showing based on the size of the market capitalization of each sector as compared to the broad market. So for example, technology, of course, being far and away the largest by market capitalization across the entire market, trading right at fair value today. I’d say probably the biggest takeaway on the screen is looking at just how little blue there is on here. Those sectors that we think are trading at a pretty good margin of safety from their long-term intrinsic valuation compared to how much is in the orange category that we think are getting to be too far into overvalued territory.

Taking a look at our sector valuations, real estate trading at the greatest discount to fair value today. That is a sector that we think will appreciate over time with monetary easing as well as the longer-term interest rates coming down as well. As we’ve talked about with real estate, my own personal view is that I’ll probably still steer clear of urban office space. I don’t necessarily like the risk/reward dynamics there, but I certainly see a lot of value in the real estate category, especially for those REITs that have tenants that are much more defensive-oriented. Energy, I would highlight this past quarter we actually increased the long term or the midcycle energy price for oil. So we bumped up our West Texas Intermediate oil price forecast to $60 a barrel from $55. And then we also bumped up our forecast for Brent up to $65 from $60. See a number of different opportunities within the energy sector. I think it also provides a good natural hedge in your portfolio. If inflation were to stay higher for longer, I think oil prices would keep up with that, and I also think it’d be a good hedge in your portfolio for any other new geopolitical risk out there.

And then healthcare, the other sector that we see value in today, the companies that I kind of prefer today are going to be those in like the devices, the medtech, and the consumable areas that I think have the best value for investors. Just want to highlight the communications sector having moved up to fair value. I took a look at some of our past outlooks. So communications I think was at like over a 40% discount to fair value in 2023, is one of the most undervalued sectors even at the beginning of 2024. It was a sector we highlighted as being undervalued here at the beginning of 2025. So really want to hand it to our communications team, to our analysts there, who have really stuck with their long-term intrinsic valuations there. Companies like Meta META and Alphabet, of course, two of the leaders in that sector that they had highlighted a while ago as being significantly undervalued.

Unfortunately at this point for investors, those stocks in our view have run their race. So they are up to fair value at this point in time. But really just wanted to congratulate that team just for the huge amount of outperformance they’ve had over the past couple of years. Running through some of these other sectors, utilities being significantly overvalued. Yes, there will be a huge increase in demand for electricity as AI continues to keep growing. Our team has already incorporated that into their model. Yes, utilities will benefit from interest rates coming down as well. We’ve already taken that into consideration in our valuations as well. But yet we still think that that has run too far to the upside. Very few opportunities in the utility sector overall. Broadly overvalued across the whole sector. Financial services, excuse me, also significantly overvalued. Yes, they will benefit as well from interest rates coming down and easing monetary policy. But in our view those stocks have already incorporated that into their valuations. We think the market is also not concerned enough about normalization of defaults and losses going forward. So we think the market is overvaluing those stocks.

And lastly, just want to highlight consumer cyclical and consumer defensive. When I look at the valuations of these two sectors, I’d note the companies within there are very barbell-shaped. So when you look at the consumer cyclical sector, the reason that’s overvalued so much is because Tesla, which is the second-largest company by market cap in there, has run too far to the upside according to our valuations. And similarly in consumer defensive, Walmart and P&G PG and Costco—stocks that we think have outperformed too much, that we think they’re trading too far above their long-term intrinsic valuation. But once you get away from those stocks in both of those sectors, we do see a lot of value. So those are sectors that are certainly much more of a stock-pickers sector than they would be just sector exposure overall. So I’m not going to go through all of these. I would just note that we do have a number of new best picks from our different sector directors on each of the different sectors outstanding. So you can use Morningstar.com or whichever Morningstar platform you use in order to do your own research and read our analysis on these different stocks.

Then just I want to wrap things up quickly here just by looking at valuations by economic moat. Really no excess value out there when we look at it by moat. I would just note that wide-moat stocks are those that are trading closest to fair value. So I would say just from a relative value perspective, those are the most attractive to me. Also in a downside scenario, I would expect that those wide-moat stocks are going to be the ones that, with their long-term durable competitive advantages that, in the downside, they would trade off less than what you would see across the rest of the marketplace. And using Morningstar tools you can look for different types of wide-moat stocks whether you’re looking for large cap, mid-cap, small cap. So in this case I’m just doing a rank order of the most undervalued on up for wide-moat stocks with either low or medium uncertainty ratings, similar for the mid-cap space, and then also the small-cap space. I’d just note in the small-cap space, there are fewer companies that we rate with a wide moat. so in this case, I also add in narrow-moat stocks. So with that I’d like to hand it off to Preston to provide his outlook for the US economy.

**Preston Caldwell: **Thank you Dave. Let me start off with a couple of points on some of the big topics. So first I want to say that the tariff shock still looks like it’s in the early stages of propagating through the US economy. So we’re likely to see more of an impact on corporate earnings in the second half of this year than we saw in the second quarter. And we’ve only seen modest pass-through into consumer prices yet, but that’s also likely to change. Second, AI has indeed become a key driver, the single biggest driver on the demand side of the economy, fueling investment expenditure as well as consumption through its effects on stock market wealth.

With that said, I will share some data that puts this into a little bit more context. The overall contribution of tech to the economy is not as out of step with recent trends over the last decade that it might seem at first glance. So, let’s dive right in. So we’re expecting real GDP growth to average 1.7% over 2025 and ’26, a little over 1 percentage points lower than the 2.8% we averaged over 2022-24. We already saw growth slow to 2% year over year in the first half of this year, and so far that doesn’t seem to be due primarily to tariffs but rather some other factors, as I’ll explain. And as those other factors continue to play out along with the delayed impact from tariffs, we should see growth hit a trough in 2026 and after that we expect GDP growth to reaccelerate as the tariff shock fades and monetary easing kicks in.

We expect inflation to tick back up to 3% in 2026 owing to delayed pass through from tariffs. But after that, inflation should return to falling again as the slower rate of GDP growth means an accumulation of slack in the economy, which will put downward pressure on prices. We expect another 175 basis points in federal-funds rate cuts, taking the target range down from 4.0% to 4.25%, currently down to ultimately 2.25% to 2.5% by the end of 2027, which is our long run expectation. Our expectations for the federal-funds rate are pretty close to market-implied expectations in the near term, but we ultimately expect the federal-funds rate to get 75 basis points below what the market’s expecting by the end of 2027, as we think that slightly elevated unemployment and slower economic growth, along with a renewed fall in inflation in 2027, should add some additional rate cuts that year. We’re still seeing the effects of high interest rates on the economy, particularly with a renewed slowdown in the housing market. The median mortgage payment as a share of household income is at 28% compared to 18% before the pandemic.

And so I think ultimately continued healthy economic growth requires lower interest rates. And so consistent with our federal-funds rate expectations, we expect the 10-year Treasury yield to fall further to 3.25% by 2028, which is our long-run expectation down from 4.1% as of today. So the current stated average tariff rate is at about 16.3% and that’s taking all of the announced tariff hikes and calculating the new tariff rate and applying that to—weighting that by 2024 import volumes. Now we expect that stated average tariff rate to rise to 17.3% by the end of this year. Baking in some probability of new Section 232 tariffs on semiconductors or pharmaceuticals, which obviously could be delayed a bit but is likely to come at some point.

After that, we expect the tariff rate to gradually fall in coming years, as the effects on higher consumer prices induces some walkback of high tariff rates and perhaps exemptions accumulate and perhaps there’s a change in political regime and then also the impending Supreme Court decision will have some impact. Now, if the Supreme Court strikes down the IEEPA tariff authority that’s been used by Trump for all the country-specific tariffs so far, that’s not going to have as big of an effect as you might think because there’s a lot of other statutory authority that could be used. And you can check out our latest US Economic Outlook for some more details on our scenario analysis there.

Now we can distinguish the stated tariff rate, which again is just applying the announced tariffs to 2024 import volumes, with the actual tariff rate, which divides customs revenue divided by total imports. And there was a very large wedge between those two in the second quarter as you can see because for one there was an exemption for goods that were in transit, which persisted well into the end of April or even early May. So they weren’t hit by the tariffs and in compliance for whatever reason seems to have lagged in May with the tariff rate changes. But eventually, the actual tariff rate actually converged quite a bit to the stated tariff rate by June.

And indeed we see that the actual tariff rate based on customs data, preliminary customs data, is up another, actual customs revenue is up another 30% in the third quarter versus the second quarter. So all this means that the actual tariff burden in terms of tariffs actually paid rose substantially in the third quarter compared to the second quarter. And so that paints a different picture of the impact of tariffs than if you were to just look at the stated tariff rate, which peaked in April. So instead that actual tariff burden is trending up.

Now, also, one factor why this probably affected company earnings, corporate earnings less in the second quarter is that companies were still selling out a pretariff inventory. And so as they shift to posttariff inventory, there will be more upward pressure on cost of goods sold. And so because of all those factors, the rising tariff burden and the increase in the depletion of pretariff inventory, we’re likely to see more of a hit to corporate earnings in the second half of this year. And so because of that, I think we’ll see also increasing pass-through of tariff costs into consumer prices, which, if you look at the bottom chart, we’ve seen very little of that so far. Even though clearly import prices inclusive of tariffs have increased by around 12 percentage points compared to the beginning of this year. But core consumer goods prices are only up about 1% since the start of this year. So that’s a very minor impact from tariffs so far.

I would expect much more pass-through to consumers because right now US businesses really are footing the tariff bill, given that rise in import prices, the foreign sectors, foreign manufacturers are paying very little of the tariff bill right now at all, if any at all. So looking at near-term GDP growth, GDP contracted in the first quarter and bounced back in the second. So if we smooth out the noise, then looking at the first half of the year, on average GDP growth was 2% year over year. So that does mark a modest deceleration compared to the growth rate in the prior three years on average. That slowdown in terms of expenditure, looking at this table, was driven by private fixed investment and government expenditure.

Personal consumption growth held steady on a year-over-year basis, even though sequentially it fell in the first half of 2025, but that was coming off a very strong second half of 2024. Slower government expenditure reflects both federal job cuts as well as slower spending at the state and local level, where postpandemic surpluses have been spent down. And within private fixed investment, as I’ll explain, despite all of the AI spending, we’ve seen a renewed slowdown in other areas of private investment, notably residential investment and commercial real estate and some other nontariff factors have weighed on that. So overall it doesn’t look like a tariff story so far, as far as the slowdown in growth, but we do think once we see more pass-through of tariff costs in the consumer prices, that tariffs will, as well as corporate earnings, tariffs will start to drag more on real activity.

Now one other factor independent of tariffs that we expect to weigh on GDP growth over the next couple of years is that the personal or household saving rate is still below where it was before the pandemic. So we expect that to eventually mean-revert a bit, which will entail slower consumption growth. Now partly this is explained by the rise in asset prices. So household net worth as a share of GDP has increased by 55 percentage points since 2019. And based on a historical regression that explains about 1.4 percentage points of the decrease in the savings rate. So that doesn’t explain all of the gap that you see. It’s about a 2.5-percentage-point gap versus the prepandemic savings rate. But it does explain a good chunk of it. If we do see a deflation in asset prices we could see consumption growth weaken much more abruptly.

And by contrast, if we see continued rapid appreciation in asset prices that could keep consumption growth very strong and avert much of the slowdown in GDP growth that we’re expecting. Of course, AI clearly is playing a role in supporting consumption growth through the stock market wealth effect. And also visibly it’s the main factor propping up private fixed investment right now, as you can see here. So without high-tech investment broadly constructed real private fixed investment would be in contraction right now, as you can see, owing to residential investment as well as a continued drag from commercial real estate.

Also some other one-time factors that were propping up strong spending like manufacturing structures from that government-subsidy-led factory-building boom that started to fade away. And so the nontech part of the economy is contracting in terms of investment spending. Now with that said, the contribution to GDP growth has been significant. In the first half of this year, we see that high-tech investment contributed about 0.7% to the overall rate of GDP growth. But that’s not as out of step with trends over the last decade as it might seem. So you can see that the rate of high-tech investment in the first half of this year was 9.4% year over year. But the 2015-2019 average before the pandemic was 7.7%. So only a moderate acceleration in high-tech investment compared to that prepandemic average.

And we’re actually slightly below where we were at the recent peak in 2021 and 22. And so why is that? Well even though we’ve had this explosion in AI data center-related spending, we’ve actually seen a slowdown in software-related spending, which is counted as part of tech-related investment because it’s capitalized by the BEA. So and R&D spending has also slowed down, too. So this broader category of high-tech investment is not skyrocketing quite as much as you would think. And that is kind of odd actually though, given that AI should be boosting the returns to knowledge work, software investment, R&D, and so on. But we’re not seeing a spending splurge by businesses yet on that stuff.

Similarly, if we look at the share of GDP—high-tech-related investment, it has reached an all-time high, but this is really more of a continuance of the uptrend, which began in the mid-2010s—a broader software- and, more recently, AI-led boom in tech related spending. And you can see that we’ve now eclipsed the prior peak set in the dot com bubble. So that is a bit of warning sign. although the rate of increase is not quite as steep as we saw in the 1990s, and you can certainly make a good argument for the prospective profitability of these investments being better than what we saw in the 1990s. although that’s certainly up for debate.

Looking at the labor market, the latest figures that we see do show a much weaker state of the labor market than we previously got based on the September preliminary benchmark figures from the BLS. And so it now looks like employment growth as of August was 0.5% year over year. So that’s considerably slower than the 1.5% averaged in the prepandemic years. And now also the unemployment rate is starting to tick up slightly, and I would say the unemployment rate is elevated above what we consider the natural rate of unemployment at about 3.7%. So I would say that considerable slack has accrued in the labor market and that’s also reflected in a continued slowdown in the rate of wage growth, too. And so this is something that is factoring into the Fed’s decision to ease monetary policy. So with that I’m going to kick it over to Kai to provide some commentary on Asian markets.

**Kai Wang: **Yeah. Hi everyone. So given that this is the first time we’ve talked about Asia stocks extensively, I’ll just go ahead and do a quick recap of what’s going on this year and as well as our outlook for the rest of the year. Our Morningstar Asia TME Index is now up 25% year to date, compared to the S&P return of 14%. So since the Trump truce with China, there’s been more of a risk-on sentiment, and the tech and communication services sectors have been the leader so far. So this comes off of a relatively low base from last year. But the key driver so far this year has included DeepSeek, the moratorium on China tariffs, the buildout of AI hyperscale infrastructure, and then Japan’s improving outlook, kind of in that chronological order there.

On the flip side there, the biggest laggard so far has been consumer stocks. Chinese consumers, I guess they spend a little bit on the wealth effect, and if you don’t know, the real estate market there has been struggling really bad. And just given all the headlines lately with major real estate developers kind of bursting and note defaults and everything. So the real estate market is kind of in a rut there, and consumer spending and consumer confidence has kind of suffered because of that. So we’ve yet to see consistent signs of stabilization in wholesale prices and same-store sales still face sluggish consumer demand, although consumer cyclical sectors here appear to have returned 21% all the way to the left there.

Much of the sector gains were driven by Alibaba BABA filled by Alibaba, they make Taobao and things like that. And that was fueled by nonconsumer catalysts such as its AI cloud revenues and AI infrastructure buildout. Alibaba also has the highest market share of AI cloud and cloud computing in China. So the gains in that sector were fueled by Alibaba for nonconsumer reasons. So while we view consumer stock as undervalued, we still believe investors could probably still underweight the sector given that the current market enthusiasm for AI-related stocks and the liquidity that they attract. So we think the liquidity will still probably go toward the tech and communication services sectors there, kind of delaying the recovery of consumer stocks.

Just some perspective and specifics on the top leaders and laggards this year so far. Tencent TCTZF, TSMC, which is Taiwan Semi TSM, Alibaba are the top leaders, and they’re all AI-related. Tencent is likely to benefit from better margins due to in-house AI benefits that should help their main business and advertising. TSMC—the story is well known here—they make chips for Nvidia NVDA, AMD, and Apple, and then Alibaba again has the biggest share in cloud computing in China, and they’ll benefit from the market leadership from the AI infrastructure buildout.

Samsung SSNLF also benefits from AI as it builds high bandwidth memory chips, which are needed for AI data centers. Same thing and the competitor of that would be Micron MU in the United States, that would be the equivalent there. SoftBank SFBQF rounds up the top five, as it has a majority ownership in ARM Holdings ARM, which is another semiconductor company. Top laggards are Meituan MPNGY, which is China’s equivalent of DoorDash DASH. It’s facing the same issues as Yelp YELP and Seamless back in the day 10 years ago, as you probably would know, Yelp and Seamless had pretty high evaluations, but they face a lot of intense competition and margin pressures in the long term.

India tariffs announced by Trump has also affected some of the securities Infosys INFY and Tata, which are two major software companies, IT companies, and then Recruit Holdings RCRRF, which is a Japanese platform which actually owns the US job site, Indeed, indicated that they’re seeing less hiring on their platform and which have lowered growth forecasts there. So what are the latest catalysts for the rest of the year? So the tech and communication services sectors are still driving the rally due to AI-related heavyweights such as TSMC, Tencent, Baidu BAIDF, Samsung, Alibaba, Samsung, SK Hynix HXSCF. Now the industrial sector was mostly propelled by Japanese companies such as Toyota TYIDF, Itochi, Mitsubishi MSBHF. Japan has contributed to Asia rally as well following the resolution of tariff negotiations between Japan and the US. So after the resolution happened, this boosted market sentiment by providing greater clarity on tariff impacts, thereby improving the domestic outlook there.

Other than AI, we think Japanese stocks could rally in the short term given the recent surprise election of Takaichi. Takaichi’s win, which was announced on Saturday, over the weekend, was a bit of surprise to some people, and this is why we saw the Nikkei go up 4% on Monday on the first trading day after the election forecast there. She’s expected to promote fiscal stimulus and have a looser monetary policy, which means that rate hikes will be less likely to lead to a weaker yen. The weaker yen should probably help companies that have high export exposure, such as Toyota, automobile companies, things like that. That will probably help markets in the short term, and we think that the Japanese market may rally because of that. But concerns remain that continued monetary easing and low interest rate in kind of inflationary environment could accelerate future inflation. So this makes it difficult for policymakers to maintain economic growth without letting inflation get out of control.

So short term we’re pretty positive on it, but long term is still to be determined what these policies may have their impact on them. So one comment on the improving corporate earnings that Japan has is that Japan’s fiscal year starts in April, and most companies tend to provide a very conservative guidance at the beginning of the year, which they are likely to beat, and often they raise guidance in the back half of the year, which we are anticipating, and this year is no different. And that’s another reason that we think we’re pretty positive on the Japanese market this year. So our current Asia coverage is trading at 1.02 times our fair value, which is fairly valued here.

Basic materials, tech, healthcare, industrial sectors, purely overvalued. While these sectors show elevate evaluations there, there are a handful of overvalued stocks that are skewing the average. So it may not reflect the opportunities that still exists within especially the industrial and tech sectors there. I think the markets have run up a lot lately because of AI-themed tailwinds and while some of the runup is justified, there’s also a lot of froth in China markets, especially with companies that have early revenue businesses or prerevenue businesses and that have unrealistic growth expectations baked into them or they have nothing to do with AI. We don’t really advise chasing some of these early revenue companies and for investors to take profit if they have exposure to them. That being said, there are going to be some companies that will benefit from AI in the long term, mostly in the semiconductor space such as TSMC, which is still one of our top names even though it’s run a lot in the past month or so. And if it pulls back, we would definitely advise investors to buy more.

Now Hon Hai, which is known as Foxconn FXCOF, they make the Apple parts, they make Apple supply chain. They also benefit from emerging AI server business. Tencent, we talked about before, it’s another name that can benefit from in-house AI. They have a hyperscaler business—they, Alibaba, and Baiu are three of the main companies in China that are able to build out AI infrastructure and data centers that can scale and develop AI applications there. AI, this is going to be a cyclical driver for TSMC, given their business is largely exposed to Nvidia, AMD, Apple, Broadcom, obviously these customers have a very robust and long-term demand for these chips there. Again, we think the tech-driven rally will continue amid the ongoing enthusiasm. But we do advise that investors consider taking profits in the overvalued names, particularly those with unrealistic growth assumptions there.

Something we like outside of AI again is the consumer sectors right now. But we haven’t really seen an inflection point there. But we still think that it’s undervalued. The restaurants, alcohol, and nonalcoholic beverages are still seeing lower consumption, which are hurting the stocks. But at some point we do think that it will recover, and at the same time we’re seeing some of these consumer companies improve their operating leverage by implementing AI technologies that could help better the supply chain. No ad targeting and operating expenses in general. So when the revenue does recover, when the revenue growth does come back and combined with its improved operating leverage, we think that we could see sharp earnings growth there.

So respective value kind of reducing the proportion of deep-value 5-star stocks. Over 30% of our coverage universe still remains undervalued in Asia there. Many of these names are concentrated in consumer. We talked about alcohol, we talked about beverage companies. For the industrial sectors, we think factory automation will come back as well. You’re going to need a lot of these robots to kind of build out these AI infrastructure as well. Right now, they have a cyclicality to them because agriculture and construction is down right now. But again we believe that they’ll come back. The proportion of 4-star stocks outweigh the 1- and 2-star names even though our coverage universe trades near fair value. Again we note that certain companies in tech and healthcare appear extremely valued but they’re skewing the overall average there. With that, that’s a quick summary of what’s going in Asia so far. I’ll hand this back to Dave.

**Sekera: **All right, thank you, Kai. Appreciate it. We’ve got a lot of great questions coming in, so let’s keep them going. In the meantime, just going to walk through a little bit of what we’re seeing across the mega-caps. A new slide for you this time around, just highlighting by company and based on the size of the market cap of the company and how much of the market it accounts for. Our star ratings, again, just showing here how little blue there is on the screen. And then we do lump in together all the 3-, 4-, 5-star stocks that are too small on the right side just to show those.

And also just note the dark gray is those stocks that we don’t cover within the US market index. But again, the US market index covers 97% of the investable stocks in the US and we do cover a pretty large percentage of those by market capitalization. Just looking at the amount of concentration in the market, you can see just how much it is concentrated, how much that concentration has increased over even just the past couple of years with the big names, the big AI names getting bigger. Similar slide here just showing you the long-term growth path for those companies. Again, I’m going to go through these slides really quickly because I want to get to some of these questions.

Just want to head off one of the questions someone was asking. “Hey, with the kind of market that we’re in, do valuations matter?” I would say yes, valuations are going to matter. Trying to find the slide I’m looking for here. Just showing four of those stocks coming into the past quarter that were rated 1 and 2 stars among the mega-caps. What we thought was overvalued. How many of those have sold off even in an otherwise increasing market? We could do a similar exercise for those mega-cap stocks coming into the year that were 1- and 2-star-rated. So yes, I certainly get the sentiment. It just feels like everything is going up no matter what. But I think once you get away from the AI headlines and you start looking at especially a lot of the stocks that I consider to be real economy stocks, a lot of those continually are struggling.

A lot of these highflyers, companies like Wingstop WING and Chipotle CMG, two restaurant companies we’d been talking about earlier this year that people were paying just ridiculously high valuations on, have sold off as well. So yes, it may take longer than what you want for valuations to work out, especially watching some of the expensive stocks seem to get more expensive. But yes, over time, valuations always do matter. And I just want to wrap this up.

Fixed-income outlook—the only thing I really want to highlight here is going to be the corporate bond market. Right now investing in corporate bonds is just purely a carry trade. I think you’re picking up nickels in front of the steamroller here. The Morningstar US Corporate Bond Index, that’s our proxy for investment-grade corporate bonds, tightened 10 basis points. I think it hits 71 basis points intraquarter. That is the tightest it’s ever been. Let me repeat that. Tightest it’s ever been. Even tighter than where we were preglobal financial crisis. Our high-yield index at 275 over, that hit 250 something intraquarter again. That also was the tightest that index had ever been, even before the global financial crisis.

So if you’re in corporate bonds today, I would just say your finger on the trigger. If you start seeing a risk-off sentiment, personally, I would just hit the bid and get out. I’d much prefer just being invested in more US Treasuries and maybe some of the other structured finance bonds than corporate bonds. I think corporate bonds are just too tight. Especially going into environment where we’re expecting the rate of economic growth to slow. I don’t think this is pricing in a more normalized default rate. I don’t think it’s pricing in an increase in downgrade risk.

And I’d also note in the private credit markets, DBRS Morningstar, which is Morningstar’s subsidiary, that’s a credit-rating agency, they rate a lot of that private credit debt. Those are private ratings, but they’re on middle market companies, call it EBITDA 10 to 100 million dollar type companies. They’ve noted for the past couple quarters they’re seeing an increasing amount of private equity sponsors having to put new capital into those investments in order to keep them afloat. They are seeing some weakening across a lot of the credit profiles there. So that is to me probably one of the first red flags out there as far as starting to see some cracks in the credit markets. Not necessarily enough to bleed into the public markets yet, but if we still see that start to increase over the next couple quarters, certainly a downside risk in my mind. And then our longer-term charts here just showing where we are, going all the way back to 2000 and where spreads had been on average in the past and how much they’ve blown out during market selloffs.

**Dziubinski: **All right, well, we will wrap there. I’d like to thank Dave, Preston, and Kai for their time and, of course, thank everyone for joining us. Before we close our webinar today, we want to hear from you. Please take a moment to vote in our poll to help shape the focus of our next quarterly Outlook session. We look forward to hearing from you, and we hope you’ll join us for our 2026 US Stock Market Outlook webinar in January. Until then, take care.