Q3 2026: Reflecting on the Investment Markets

“In times of change learners inherit the earth, while the learned find themselves beautifully equipped to deal with a world that no longer exists.” Eric Hoffer, Reflections on the Human Condition.

• The U.S. Federal Reserve (Fed) raised interest rates in response to stubbornly persistent inflation fueled by elevated energy prices.
• Equity markets experienced higher volatility and interest-sensitive stocks sold off, but artificial intelligence (AI) stocks continued to perform on strong second-quarter earnings.
• Bond yields rose as markets sold off in the face of rising interest rates.

Economic Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

The third quarter of 2026 brought renewed pressure on energy prices, a widening of supply disruptions resulting from the U.S./Iran conflict, and the Fed’s first interest rate hike since 2023. The geopolitical relief rally that helped equity markets rebound in the second quarter gave way to a more turbulent environment as implementation of the June peace framework proved slower and more complicated than markets had previously discounted. Brent crude prices rose through the summer, surging back above $100 per barrel in the weeks before September’s Federal Open Market Committee (FOMC) meeting. The shutdown of the East-West Crude Oil Pipeline on September 11 added a new layer of supply disruption beyond the still-complicated situation in the Strait of Hormuz, underscoring the continued fragility of the energy recovery.

Despite these formidable headwinds, the U.S. economy held its footing through the third quarter. Annualized real GDP growth came in at 2.2% in the second quarter, up marginally from 2.1% in the first quarter. GDP growth has faced several headwinds, including a decline in government spending and lower exports. However, AI-driven demand provided a cushion from the energy shock that might otherwise have resulted in a more stagflationary environment.

Under new chair Kevin Warsh, the Fed raised interest rates by 0.25% in a unanimous vote at the September FOMC meeting. Fueled by surging energy prices, inflation remains well above the Fed’s 2% target rate. This hawkish move by the Fed could be interpreted as a precautionary measure designed to signal its commitment to stable prices and curtail inflation expectations before they become unmoored.

The macro picture remains one of uncomfortable durability. The economy continues to grow and corporate earnings remain strong, anchored by AI-driven revenue growth across the Information Technology sector. But inflation has not yet been convincingly tamed, and the full economic cost of the energy disruption in the Middle East remains to be counted.

Stock Market Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

Against the headwinds of rising rates, elevated oil prices and geopolitical uncertainty, equity markets delivered a volatile quarter with mixed returns. Thus far in 2026, equity markets have already been through three distinct regimes: a first-quarter geopolitical shock and correction, followed in the second quarter by a peace-deal-and-earnings surge, and then a third quarter characterized by an energy price re-escalation combined with the Fed’s interest rate increase.

Despite this complex environment, the S&P 500 Index finished the third quarter up 2.30% and 12.73% year-to-date. The quarter’s most significant structural story was not the index return but the sector dispersion beneath it. The Energy sector, on the back of oil prices rising back above $100 per barrel, rose 17.23% in the third quarter and 40.28% year-to-date. Stocks in the Information Technology and Health Care sectors were up 7.20% and 6.46%, respectively, despite some intra-quarter volatility. Technology stocks have continued to enjoy support from durable AI earnings and continued investor confidence that the AI capital expenditure cycle would remain healthy enough to weather a rising cost of capital. At the other end of the spectrum, stocks in the Utilities sector were down -12.39% in the quarter and down -5.65% year-to-date, as rising rates resulted in a sell-off in rate-sensitive sectors. Industrials (-9.66%), Consumer Discretionary (-5.09%) and Real Estate (-5.57%) were other sectors in the red over the third quarter. The Russell 2000 Index sold off, down -7.29%, but remains up 13.87% for the year.

Developed international equity markets navigated a difficult quarter as the headwinds that impaired their performance in the previous quarter persisted. The MSCI ACWI ex-US Index was up 0.48% in the third quarter, and 14.23% for the year. Emerging markets struggled, but performance of the MSCI Emerging Markets Index was up a robust 23.38% year-to-date. Europe’s energy vulnerability remained acute, and the European Central Bank, having postponed its planned rate cuts in March, remained unable to resume easing in the face of elevated energy-driven inflation. The dollar began to strengthen in the quarter, and the Fed’s interest rate hike in September contributed to a weakening of the currency tailwind that had amplified international equity returns for U.S. investors in 2025. The structural valuation case for international equities remains intact on a multi-year view, but currency volatility remains a wild card in the current environment.

Bond Market Review and Outlook

Index return data provided by Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities.
It is not possible to invest directly in an index.

Rising interest rates dominated the bond market story in the third quarter, as bond market indices declined. The Bloomberg US Aggregate Index fell -3.51% and the Bloomberg Muni Index fell even further, dropping 6.35% in the quarter. While bearishness in the bond market was prevalent throughout the third quarter, the sell-off accelerated in September on the heels of the Fed meeting and another surge in oil prices. Municipal bonds were more affected by the sell-off, as heavy issuance in September combined with tax-loss selling to drive muni prices even lower.

Tighter monetary policy was not the only source of anxiety for the bond market in the third quarter.  While the short end of the yield curve responded to the Fed’s tightening, the long end of the curve is much less sensitive to Fed policy and is governed by the balance between supply and demand for long-duration bonds. Elevated inflation expectations and an increase in the supply of long-term debt issuance by firms funding the AI build out exerted pressure on bond markets, as did growing concern about the large and expanding federal budget deficit. This scenario drove bond prices lower and bond yields higher for intermediate and long-term bonds. More restrictive monetary policy has resulted in the front end of the yield curve repricing higher, offering investors a positive real rate of return relative to inflation.

While the third quarter’s bond market correction and increasingly complex macroeconomic environment may be unnerving, some comfort can be found in the fact that higher bond yields offer the potential for higher prospective returns for bond allocations. It’s worth remembering that the ability to reinvest capital at higher yields – in effect, the “interest on the interest” – is a primary driver of long-term returns for bondholders. As such, long-term investors may be well served by viewing this quarter’s bond market slide as an opportunity to reposition their portfolios for success moving forward.

Portfolio Implications

September’s interest rate hike and the signal of further tightening represent a meaningful recalibration of the fixed income opportunity set. With the federal funds rate now at 3.75%–4.00% and the 10-year Treasury yield above 5%, the yield available on high-quality fixed income further supports the argument for extending duration to capture incremental income.

• Take advantage of higher long-term bond yields. One of the most important factors in estimating the forward returns for a bond portfolio is its starting yield. With the 10-year Treasury currently yielding 5.29% and the 30-year Treasury yielding 5.64% at quarter-end, high-quality bonds offer their most attractive returns in recent years. For investors in top tax brackets, tax-exempt income may become even more valuable in these conditions, arguing for a core allocation to municipal bonds for these portfolios. On September 30, the Bloomberg Municipal Bond Index yield to worst was 4.80%. That equals a taxable-equivalent yield of roughly 7% or higher for an investor in the top federal bracket, before any state tax benefit.
• Diversification in equities remains crucial. Recent market volatility underlines the importance of proper diversification in equity allocations. The third-quarter rally in energy stocks provides a recent example, and portfolios overly concentrated in other areas of the market may have missed out on those attractive returns. While trying to time sector allocations is always a near-impossible task, doing so in the current environment would seem to be futile. Overall, we continue to be constructive on equities, as earnings remain broadly robust. International equities remain attractive on a relative-valuation basis, and we believe they should be held as a strategic allocation rather than trying to trade them on recent performance.
• Utilize alternative investments to broaden portfolio diversification and asset allocation customization. Alternative investments are typically treated as a strategic allocation, sized to each investor’s liquidity needs and time horizon. The third quarter offered examples of heightened correlation between stock and bond returns in an environment characterized by supply shocks. This means that other sources of diversification, such as alternative investments, may be useful tools. For suitable investors, alternative investments and private markets may offer an opportunity to further diversify portfolios by utilizing strategies such as private structured credit, infrastructure, private equity and hedge funds. Investors who take a global approach when allocating to both traditional equities and alternative investments may achieve even greater diversification.
• Remain vigilant in tending to portfolio management details. Increased levels of market volatility provide investors with opportunities to rebalance portfolios. For taxable accounts, many investors can improve their after-tax returns by using direct indexing to help maximize tax-loss harvesting, and by having a disciplined approach to asset location.

Conclusion

The third quarter of 2026 was yet another test of investor resilience. On February 28, the U.S. and Iran began a still-ongoing war, which has been punctuated by a ceasefire, followed by a re-escalation, then a period of relative quiet, before additional strikes in September. President Trump’s tariffs imposed under the IEEPA were deemed unlawful by the Supreme Court in February but were reimposed by other means throughout the year. Inflation reaccelerated in the late spring and summer as energy prices surged, prompting the Fed to raise rates in September. As well, the AI build out continued apace, with concerns over the size of the capital investment required to create the needed infrastructure offset, at least for now, by strong earnings in the Information Technology sector.

The world continues to change, providing both new challenges and opportunities for investors. Geopolitical relationships will become reordered, new technologies will arise with the potential to fundamentally change how we live and do business, and opportunities to utilize previously difficult-to-access investment vehicles will likely surface. Being strategic in your investment approach doesn’t require sealing your portfolio in amber, never to be changed. Portfolio management is an iterative process of continual learning and adaptation. We believe that investors are well served by thoughtful portfolio management that continues to improve and adapt portfolios as the world and the opportunities it presents continue to evolve.

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