Q4 2025 Client Letter

By Bruce Thompson on October 1, 2025

Editor’s Summary

Markets have delivered strong returns year-to-date, supported by easing rates, moderate inflation, a pro-business environment, all-time high corporate profit margins, and steady consumer activity. Yet elevated equity valuations argue for balance and discipline. We continue to emphasize controllable drivers of long-term portfolio outcomes — asset allocation, diversification, and “time in the markets” as opposed to “market timing.” Faithful rebalancing is an important element of asset allocation strategy. Against this backdrop, we view the present as an opportune time to rebalance and re-affirm risk levels so portfolios remain aligned with goals and capacity for risk.

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Editor’s Note

Margin of Safety

The day-to-day immediacy of the markets doesn’t lend itself well to stepping back and assessing the big picture. Investors grapple with “infobesity” — an overload of information which may lack perspective, often portending certainties that don’t exist. Our goal is to arm you with balanced insights to help you set expectations and remain centered as an investor.

Sometimes that means presenting “two sides of the same coin,” as you’ll note in this quarter’s market review. This reflects the financial system’s nature — a complex, multivariate “weighing machine,” as Benjamin Graham famously described the stock market.

The takeaway: Be mindful of the information you consume. Apply filters. Seek balance. We all struggle with confirmation bias — the tendency to favor data that supports what we already believe. Whether it’s the stock market, interest rates, earnings, geopolitical tensions, economic data, or shifts in investor confidence, the future remains inherently unknowable.

That’s the essential message contained in Graham’s The Intelligent Investor, which offers timeless wisdom — and a disciplined framework for managing risks. The chapter “The Investor and Market Fluctuations” remains one of the most valuable things an individual investor could ever read.

His wisdom endures because it recognizes that the risks we face and must manage are both external and internal — behavioral. Markets have evolved, but human nature hasn’t. Fortunately, with more people than ever investing toward life goals, we can draw on such lasting insights.

Graham’s framework begins with a foundational intellectual leap — discerning and accepting what can and cannot be known. Investment management, then, requires consistent, disciplined control of risks — external and internal — with singular focus on what effectively can be managed.

To help us stay centered on those investment management factors we offer an acronym – ADEPPTS:

• Asset Allocation
• Diversification
• Expenses – investment-related costs in relation to the value added
• Psychology – behavioral risks
• Price – or market valuations – rebalancing
• Taxes
• Savings and Spending — within a financial plan

Graham’s thinking laid the foundation for what today is known as Asset Allocation. Decades later, modern portfolio theory provided the statistical justification for Diversification. Today, asset allocation and diversification represent the primary strategies for balancing and maintaining portfolio risk according to each client’s financial and behavioral capacity for taking risk.

These strategies are so powerful precisely because they encourage disciplined focus on what Graham called “time in the market” rather than “market timing,” which he thought would lead to speculation — and to “a speculator’s results.”

“The farther one gets from Wall Street, the more skepticism one will find as to the pretensions of stock-market forecasting or timing. There is no basis in logic or experience for assuming that any [investor] can anticipate market movements more successfully than the general [market], of which he is himself a part.”

Time in the market matters because, over longer periods, markets tend to revert toward median returns — and because of the magic related to compounding

Figure A as of 12/31/24                                       

Figure B as of 12/31/24

Over shorter periods, market momentum — cycles of fear and greed — can drive prices far above or below fundamentals, with inverse implications for safety and future returns. Periods of high prices – market valuations — provide narrower Margins of safety. Conversely, periods of low valuations provide wider margin for error.

Over shorter periods, market momentum — cycles of fear and greed — can drive prices far above or below fundamentals, with inverse implications for safety and future returns. Periods of high prices – market valuations — provide narrower Margins of safety. Conversely, periods of low valuations provide wider margin for error.

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“It is for these reasons of human nature that we favor some kind of mechanical method for varying the proportion of stocks to bonds in the investor’s portfolio.”

At all times, maintaining a margin of safety means never investing beyond one’s capacity for risk. Familiar disciplines — investing, spending, and saving within a financial plan –maintaining adequate liquidity to meet planned spending — build investment staying power and minimize the potential for emotion-driven decisions.

As you read our quarterly market review, you’ll see why we’ve revisited these core principles. Market valuations are quite high relative to historical averages. We offer some perspective on what that might imply for intermediate returns, while noting that current momentum may persist — and exploring what may justify today’s prices.

The key takeaway is that high valuations suggest narrower margins for safety — portfolio risk has risen relative to investor limits. Lexington’s Investment Committee uses valuation data to refine equity return expectations, inform financial-planning assumptions, and rebalance asset-allocation models. The rebalancing process, designed realign risks within stated limits, is managed by your advisor and guided by a deep understanding of your unique circumstances.

Beyond rebalancing, if you have concerns about your asset allocation and strategic positioning, now is an excellent time to discuss them. Up markets offer the best time to review your investment plan since, if adjustments are desired, they can be made from strength.

At Lexington Wealth, one of our core competencies is helping clients define risk boundaries — and to understand the risks embedded in your portfolios and financial plans.

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Investment Review

Figure 1

It’s remarkable that the stock market climbed so strongly this year amid worries about tariffs, policy uncertainty, political turmoil, and extended valuations. So far in 2025, global stocks (MSCI All Country Index) are up 18.4%, U.S. stocks (S&P 500 Index) 15.5%, and bonds (Bloomberg Aggregate Index) 6%.

As a side note, clients should keep the 3-yr equity returns in perspective.  The S&P 500 returned 25% annually over that period, but this corresponds with the 2022 bear market low, after stocks had fallen roughly 25%.

Leading this year’s rally were international markets, returning 26%, with strong gains in Canada, China, Brazil, and the Eurozone, driven by renewed interest in the Aerospace and Defense sector. The MSCI EAFE Index returned 25.7% in U.S. dollars compared to 13.6% in local currencies — reflecting the dollar’s decline.

The government shutdown adds to the list of worries, but markets have largely shrugged it off. Historically, shutdowns have had little long-term impact on stocks (Figure 2).

Figure 2

During Q3 , stocks rallied ahead of the Fed’s telegraphed September rate cut, then mostly yawned after the announcement. The Fed lowered its benchmark rate by 0.25%, to a range of 4.00%–4.25%, roughly in line with pre-2008 norms. (Figure 3).

 The Fed’s stance reflects a nuanced balancing act: supporting a cooling labor market while remaining watchful for inflation. Fed Chair Powell noted that while recession risks remain limited, labor demand is softening — partly offset by ongoing supply constraints.

In plain English: while unemployment remains low at about 4.5% (versus a 50-year average of 6.1%), job openings are declining (Figure 4) — often a leading indicator of weakening job market. On the supply side, demographic changes are crimping the number of workers — retiring baby boomers, post-Covid lifestyle shifts, and fewer foreign-born workers – which may be masking labor weakness and distorting headline data.

Figure 4 as of 9/30/25

Figure 5 as of 9/30/25

Further complicating the picture, the rapid adoption of Artificial Intelligence may be driving structural changes, boosting productivity and reshaping labor dynamics.

With Fed rates near 4% — not 0% — the Fed has room to lean toward easing. Investors’ bullish mood relies at least in part on confidence – possibly overconfidence — that the Fed can cut rates more significantly and provide a backstop in the event of economic weakening. But that picture is complicated as the Fed must navigate between inflation, potential impact of tariffs, recession risks, and shifting labor markets, heightening the risk of policy errors.

Those risks are magnified by the fact that equity valuations are quite elevated in historical context. The bedrock margin of safety for stocks is narrow – the relationship between prices and earnings — and it is important for clients to remain realistic about what that means for future returns.

Momentum, the tendency for asset prices to continue recent trends, is an undeniable force in markets. Based on experience, market momentum – upward and downward — can stay in place much longer than one expects. Currently, upward momentum in stocks is well-entrenched. It is driven by confidence or possibly overconfidence in earnings growth and fear of missing out. And by reluctance to buy lagging asset classes, as reflected in the dangerous concentration of money flowing into AI related stocks.

But as the saying goes, an object in motion tends to stay in motion — until gravity asserts itself. We are quick to point out that, of itself, the stock market’s valuation level is not a dependable short-term market-timing indicator. Markets don’t tend to sell off just because valuations are elevated. Rather, some other catalyst emerges causing earnings expectations to fall. Elevated valuations become obvious after the fact.

“Rocket ship” rallies tend to launch from low not high valuation levels, as you can see in Figure 6. For example, the P/E was 15.7x in October 2022, 13.3x in March 2020, and 10.4x in March 2009.

By contrast, today’s P/E ratio is 22.8x, exceeded only by the May 2000 reading of 25.2x, near the top of the late 1990’s tech bubble. And that is a “forward” P/E ratio, meaning analysts’ estimates for earnings growth in the next 4 quarters are assumed.

Figure 6, as of 9/30/25

Figure 7, as of 9/30/25

The data in Figure 7 plots rolling 1-yr and 5-yr annualized returns in the S&P 500 Index since 1990, grouped by starting P/E ratio levels.  The red line shows an inverse relationship between starting P/E ratios and subsequent median returns. From P/E ratios near today’s levels, the median 1-yr returns were in the low single digits, and the 5-yr returns were near 0.

Over 1-yr periods, there were many instances when returns were well above and below the median – over short periods anything can happen. But over 5-yr periods the returns were uniformly low. 

As pointed out in our Editor’s Note, there is another side to this coin – reasons for optimism. A relatively modest decline in the P/E to under 20x significantly improves the median return picture. Analysts are forecasting a sharp rise in corporate earnings, as presented below.

Figure 8

There are reasons for investor optimism: pro-business policy, deregulation, supportive tax measures, and renewed GDP growth which came in at 3.8% last quarter. Inflation remains contained as tariff effects, for now, have been offset by related inventory adjustments and supply chain shifts.

High corporate profit margins (Figure 9) often have led sharp upswings in earnings growth. Profit margins are at all-time highs, suggesting strong pricing power, rising worker productivity, and operational efficiency. The recent uptick in productivity – meaning the economy can grow more with less resources – follows a decade of slowing.

Artificial Intelligence (Figure 10) may be playing a major role here, just as past technological revolutions — electrification, the automobile, aviation, the internet — resulted in big increases in labor productivity.

Figure 9

Figure 10, as of 9/30/25

Outside the U.S., valuations remain significantly lower. Eurozone stocks trade at 14.8x, well below U.S. levels and in line with long-term averages. International markets continue to offer better margins of safety and represent attractive diversification opportunities.

Figure 11, as of 9/30/25

In Closing

Clients should remain realistic about recent strong equity returns and high valuations for U.S. stocks. This is not a fire alarm. Just as we advise patience during downturns, it’s equally important to temper expectations during rallies and avoid chasing performance. We continue to advocate for broad diversification across asset classes and geographies—a steady, disciplined approach designed to capture opportunities and manage risk wherever they arise.

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Lexington Wealth Management is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Lexington Wealth Management and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Lexington Wealth Management and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates. Disclosure must be spoken/read at the end of the podcast. Videos must display the disclosure at the end of the video for an appropriate length of time for the user to read.