MARKET OUTLOOK / STRATEGY
Third Quarter 2025
Our base case is economic growth to be positive with the potential to slightly improve in the near term. The
recent tax bill provides a tailwind for corporations, and large commitments to AI-driven capital investment
could further boost economic growth. Overall consumption should remain resilient, driven by the wealthiest
households, while lower-income households continue to face pressure from cumulative inflation and stagnant
real wages. The current political environment and the risk of exogenous shocks pose risks to markets and the
economy. The distribution of potential outcomes is large and offers both challenges and opportunities as we
shift into the next quarter. We remain very vigilant.
Inflation remains above the Fed’s target. Tariffs have had less impact on consumer prices than expected, with
producers absorbing much of the cost to date. However, both markets and policymakers anticipate greater
pass-through in the coming quarters. With tariff policy still in flux, the outlook for inflation carries more
uncertainty than in recent years. Although interest rate volatility has been declining, it could rise again if
these risks intensify. We maintain a neutral stance to duration. Our 12-month trading range for the 10-Year is
3.0-5.0%.
“Yields pay the bills” and overall yields continue to have attractive risk/reward characteristics. Demand for
credit remains strong and is likely to persist as the credit quality of corporate indices improves. At the same
time, the risk premium on U.S. Treasuries is rising with expectations of heavy issuance ahead. The ability to
compound coupon income through reinvestment further enhances the appeal of U.S. credit market, supported
by its size and depth of liquidity.
Corporates have shown resilience, and management teams remain constructive despite recent volatility.
Earnings are projected to rise in the coming quarters, supported by capital investment. M&A activity is
expected to increase; however, management teams have expressed prudence in execution as it pertains to use
of their balance sheets. Given tight spreads and ongoing uncertainty, we see sector and issuer level
diversification important to balance risk and return. We are modestly overweight Corporates, with an
emphasis on short and intermediate maturities and BBB issuers, maintaining a focus on stable to improving
credits.
Within structured products, we hold a modest overweight to MBS given their defensive profile, strong
liquidity, and attractive relative value versus corporates. We recently trimmed the overweight following
outperformance and spreads moving to the tighter end of their range, but would look to add should spreads
widen. High-quality, short-duration ABS is a top overweight, supported by a resilient consumer and a low
probability of recession. While delinquencies remain elevated, we are comfortable leaning on structural
protections and security selection, with a focus on larger, more established issuers. Non-agency CMBS offers
attractive spreads but continues to face pressure from the office sector. We maintain an opportunistic stance
in the sector, with a focus on new issue opportunities.
DISCLOSURE
Past performance is not a guarantee or a reliable indicator of future results. Investing involves risk; principal loss is possible. Investors should carefully consider risk when investing in bonds or other securities, which include, but are not limited to, default, credit rating, interest rate, duration, prepayment, liquidity, and structural risks. Securities are also subject to general market risks due to factors that affect the overall market, which may include, but are not limited to, government actions, investor behavior, and economic conditions. Economic conditions may be influenced by liquidity risk, geopolitical risks, monetary and fiscal policy, interest rate risk, and inflation, among others. There is no guarantee that investment strategies presented will work under all market conditions. Risk management processes including diversification cannot eliminate the risk of losses nor assure the likelihood of a gain. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn or volatility in the market. Refer to the Legal & Disclosures section for additional disclaimers and disclosures regarding performance, risk, and investment process.
Information presented is for informational purposes only. It is not intended as investment advice nor an opinion or a recommendation as to the appropriateness of investing in any particular security, asset class, strategy, or product. Nothing in this publication is intended to be relied upon as a forecast or research; legal, tax, securities, or investment advice. Nothing in this publication is a solicitation of any type.
This commentary contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions, outlook, and strategies are subject to change without notice. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
This report is intended for U.S. institutional investors only. No part of this material may be modified, distributed or duplicated without the explicit permission of Pugh Capital Management.
Source: Pugh Capital, Bloomberg, and Bloomberg Indices.
As of September 30, 2025.