Q3 2026 Market Perspective

The third quarter reinforced a theme that has been developing throughout 2026: the economy remains resilient, but the investment environment has become more demanding.

Economic growth continues, corporate fundamentals remain generally healthy, and equity markets have been supported by strong earnings expectations. At the same time, several of the trends that helped broaden market participation during the first half of the year lost momentum. Long-term interest rates moved meaningfully higher, the U.S. dollar strengthened, and geopolitical pressures continued to influence energy prices and inflation expectations.

The most significant development during the quarter occurred in the fixed-income markets. The yield on the 10-year U.S. Treasury rose to 5.28% at September 30, reaching levels not seen since 2007. While that increase created near-term pressure on bond prices, it has also materially improved yields available to investors.

In our view, this backdrop remains consistent with the late-stage economic cycle discussed last quarter. Late-cycle conditions do not necessarily imply an imminent recession, but they tend to place greater importance on valuation, financing costs, balance-sheet strength, and selectivity.

For long-term investors, we believe the appropriate response remains balance rather than reaction. Diversification remains important as market leadership changes, while today’s higher bond yields are creating opportunities that have been largely absent from fixed-income markets for many years.

Source: Q3 2026 Total Return as of 9/30/2026, Bloomberg^[1]

• The third quarter represented a pause in the market broadening that characterized much of the first half of the year. Earlier in 2026, small- and mid-cap stocks, along with international and emerging-market equities, participated more meaningfully in market gains. During the third quarter, leadership shifted back toward larger U.S. companies, particularly those associated with technology and AI-related investment. 
• Higher financing costs help explain part of that shift. Smaller companies tend to be more dependent on external financing and are generally more sensitive to refinancing costs. International investments also faced the headwind of a stronger U.S. dollar, which can reduce translated returns for U.S.-based investors and tighten financial conditions globally.
• Fixed income experienced a more pronounced adjustment. The 10-year Treasury yield ended September at approximately 5.28%, while the Bloomberg U.S. Aggregate Bond Index declined 2.61% during September and 2.91% year-to-date. Although falling bond prices are uncomfortable in the short term, the corresponding rise in yields has improved the income opportunity available to investors today.  

MARKET DRIVERS

Resilient Growth Meets Tighter Financial Conditions

The economy has continued to demonstrate resilience. Second-quarter GDP grew approximately 1.5%, private domestic demand strengthened, and labor conditions have remained sufficiently healthy to keep recession risk contained.^[2]

At the same time, inflation and interest rates have become more important risks. Inflation remains above the Federal Reserve’s longer-term target, producer-price pressures have persisted, and the Fed raised rates by 25 basis points during the quarter.

This combination remains consistent with our assessment that the economy is in the late stage of the current cycle. Growth is still positive, but monetary policy is restrictive and the cost of capital has risen.

A 10-year Treasury yield near 5% matters well beyond the bond market. Treasury yields influence mortgage rates, commercial real estate financing, corporate borrowing, capital investment and ultimately the valuations investors are willing to place on financial assets.

Higher rates do not necessarily end economic expansion. They do, however, gradually raise the hurdle for new investment and create greater differentiation between companies with strong balance sheets and those more dependent on inexpensive financing.

FEATURED DEEP DIVE: WHAT IS DRIVING INTEREST RATES HIGHER?

The movement in the bond market deserves particular attention this quarter.

The yield on the 10-year Treasury increased from approximately 4.16% at the beginning of 2026 to 5.28% at September 30, an increase of roughly 112 basis points.^[3]

An important part of that move has occurred in what bond investors refer to as the real yield, or the return available after accounting for expected inflation. During September, the real yield on the 10-year Treasury increased from approximately 2.44% to 2.93%, while longer-term inflation expectations remained relatively stable.

In practical terms, investors were not simply demanding more yield because they expected significantly higher inflation. They were also requiring greater compensation, after inflation, to lend money to the U.S. government for an extended period.

There is rarely one explanation for a move of this magnitude. Instead, several forces appear to be contributing.

Resilient economic growth and persistent inflation. Economic activity has held up better than many investors expected despite elevated borrowing costs and geopolitical uncertainty. A stronger economy reduces demand for traditional safe-haven investments and raises the possibility that monetary policy will remain restrictive for longer. Energy-price pressures related to geopolitical events have added another layer of inflation uncertainty.

Greater supply of bonds. Corporations are issuing substantial amounts of debt to fund investment, including the extraordinary capital requirements associated with AI infrastructure. We discussed last quarter how the AI theme has expanded beyond equities and into the credit markets. Greater corporate supply must compete with Treasury issuance and other borrowers for investor capital.  

Fiscal and government borrowing concerns. Persistent deficits have increased the amount of debt governments need to finance. This is not exclusively a U.S. issue. Greater sovereign borrowing globally increases competition for capital and may require higher yields to attract buyers.

Global and geopolitical pressures. Rising defense expenditures, energy disruptions, political uncertainty overseas, currency pressures, and trade-related inflation concerns have also contributed to a market in which investors are demanding greater compensation for risk and duration.

Rather than attributing the increase in yields to any single factor, we believe the more useful question for investors is what today’s higher interest rates mean for portfolios.

Why Consider Bonds Now?

For investors who already owned longer-duration bonds, the adjustment in interest rates has been painful. Bond prices generally decline when market yields rise, which explains much of the weakness experienced by high-quality fixed income this year.

The other side of that relationship, however, is increasingly attractive.

Higher yields mean that capital can now be invested at income levels that have not been broadly available for many years. Our fixed-income team currently sees opportunities to build portfolios of high-quality, intermediate-term corporate bonds with yields in the approximately 5.5%–6.0% range. High-quality intermediate municipal bonds may offer yields near 4%, translating into meaningfully higher taxable-equivalent yields for investors in higher tax brackets.

Starting yield is important because income represents a substantial portion of a bond investor’s prospective return over time. Today’s higher yields also provide a larger cushion if rates rise further.

When yields were extremely low, relatively small increases in interest rates could overwhelm the income generated by a bond portfolio. With starting yields now materially higher, investors receive substantially more income while waiting.

Intermediate-term bonds may also provide another potential benefit. If economic growth eventually slows or inflation moderates, long-term rates could decline, creating the potential for price appreciation in addition to coupon income.

There are tradeoffs. Rates could remain elevated or move higher if inflation persists, economic growth remains stronger than expected, or government borrowing continues to increase. For that reason, we believe the opportunity favors selectivity rather than simply pursuing the highest available yield.

Credit quality is equally important. Lower-quality bonds may offer higher yields, but borrowers with weaker balance sheets have less flexibility when refinancing costs rise. In a late-cycle environment, we continue to favor high-quality issuers with strong cash flows and manageable debt burdens.

THE EQUITY MARKET: HEALTHY EARNINGS, NARROWER LEADERSHIP

Corporate earnings continue to provide meaningful support for equity markets. S&P 500 earnings are expected to increase significantly from the prior year, and estimates moved higher during the quarter.

However, the strength remains uneven.

Energy, semiconductors, communications companies, and businesses connected to AI-related infrastructure have generated an outsized portion of earnings momentum. Technology and communication stocks were among the strongest areas late in the quarter, while more interest-rate-sensitive sectors experienced greater pressure.

This helps explain why large-cap equity markets have remained resilient even as market participation has narrowed from the broad gains experienced earlier in the year.

The AI infrastructure buildout remains an important investment theme, but higher financing costs raise the standard by which those investments should be judged. As we discussed last quarter, the next phase of the AI cycle may depend less on how much companies spend and more on whether those investments generate attractive and sustainable returns.

Pros & Cons of the Current Environment

There are reasons to remain constructive. Economic growth continues, corporate earnings remain supportive, recession risk remains contained, and higher bond yields have materially improved prospective income.

At the same time, the market has become less forgiving. Higher interest rates increase financing costs, market leadership has narrowed, inflation remains above target, and geopolitical developments continue to influence energy prices and investor sentiment.

This combination is characteristic of a more mature economic cycle: opportunities remain, but valuation, quality and diversification become increasingly important.

Risks & What We’re Watching

As we move into the final quarter of 2026, we are closely watching several areas.

Inflation and Treasury yields remain central. Persistent inflation could keep monetary policy restrictive and maintain upward pressure on longer-term borrowing costs.

Labor-market conditions and credit trends may provide evidence of whether higher interest rates are beginning to materially slow the economy. We are particularly attentive to employment breadth, housing activity, capital spending and lower-quality credit.

Energy prices and geopolitics remain important because they can affect inflation, household purchasing power and corporate margins simultaneously. Energy inflation can pressure broader “throughput” inflation by raising transportation, logistics, utility and other input costs across the economy. While these effects may initially appear most clearly in headline inflation, a sustained rise in energy prices can eventually feed into core goods and services through higher production costs, business pricing decisions and inflation expectations.

We are also monitoring the U.S. dollar and the evolution of market breadth. A combination of stable economic growth, cooling inflation and energy prices, and stabilization in long-term yields could create conditions for market participation to broaden again.

SUMMARY

The third quarter demonstrates that resilient economic growth does not necessarily produce uniformly strong financial markets.

The economy continues to expand and corporate earnings remain supportive, but higher long-term interest rates have raised the cost of capital and created greater dispersion across stocks, sectors and asset classes.

For fixed-income investors, the repricing of the bond market presents both a challenge and an opportunity. Near-term returns have been affected by rising yields, but today’s higher starting income provides investors with improved compensation for assuming duration.

Our approach remains centered on strategic asset allocation, diversification, disciplined rebalancing and ongoing tax management. Within equities, we continue to favor late cycle asset classes, such as large cap US stocks. Within fixed income, today’s environment supports selective exposure to high-quality intermediate-term bonds while maintaining discipline around credit risk.

Narrower market leadership does not diminish the importance of diversification. It reinforces it.

As always, our focus remains on aligning investment decisions with each client’s long-term financial plan and maintaining the discipline necessary to navigate changing market conditions.

APPENDIX

Chart A: 2026 Total Return of Major Asset Class Indexes

Source: Bloomberg; 2026 Total Return, MSCI EAFE, MSCI Emerging market, S&P 500, Barclays Agg & Barclays Muni indexe; 9/30/2026

1 – Bloomberg: S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index 

2 –  https://tradingeconomics.com/united-states/gdp-growth 

3 –  https://tradingeconomics.com/united-states/government-bond-yield

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