Global Market Review and Outlook

The third quarter offered a stark reminder that much can happen beneath a calm-looking surface. On paper, the U.S. equity market had another respectable quarter, with the S&P 500 gaining 2.3% and setting fresh record highs in August and early September. Underneath the surface, however, it was a far more turbulent period. The small-cap Russell 2000 fell 7.2%, international markets were essentially flat, and bonds, as measured by the Bloomberg U.S. Aggregate, lost 3.5% in their most difficult quarter since 2022. Put simply, the collapse of the U.S.–Iran ceasefire sent energy prices sharply higher, rekindling inflation and pushing the Federal Reserve into its first rate hike in more than three years. This combination rewarded energy-related businesses and the AI-driven technology leaders whose earnings kept surging, while punishing bonds and nearly every other rate-sensitive corner of the markets.

Asset Class Returns – Periods Ending September 30, 2026

Source: FactSet; WSJ Market Data, EIA and goldprice.org. Data as of 9/30/2026.

The relative calm in the Middle East that helped fuel the second-quarter equity rally proved short-lived. U.S. strikes on Iran in early July reversed an oil price easing that had briefly returned to pre-war levels. By early September, the U.S. and Iran were routinely exchanging fire in and around the Strait of Hormuz; as a result, Brent crude prices neared $100 a barrel. The impact on households has been real: the average price of a gallon of regular gasoline reached roughly $4.47 at the end of September, about $1.35 more than a year earlier.

Higher energy prices flowed directly into inflation data. Headline CPI rose 3.4% over the 12 months ending in August. Energy prices alone were up more than 16% from a year earlier, while producer prices rose 5.4%. Encouragingly, core consumer inflation, which strips out food and energy, remained comparatively contained at 2.4%, and the Fed’s preferred PCE inflation measure came in slightly below expectations late in the quarter. That was not enough, however, to keep the Fed from intervening. It voted unanimously in September to raise its benchmark rate by a quarter point to a range of 3.75%-4.00%, its first increase since July 2023. More important to markets was the signal that more may come: the median projection of Fed officials now calls for one additional hike before year-end and for rates to hold near that level through 2027—a stark contrast to the multiple cuts that were expected when the year began.

Meanwhile, through it all, the U.S. economy continues to expand nicely. Retail sales increased 1.2% in August and inflation-adjusted consumer spending rose a solid 0.6% for the month. Second-quarter GDP growth was revised up to 2.2%, and early tracking estimates suggest third-quarter growth could come in at 3% or better, supported by consumer spending and the enormous wave of AI-related business investment. The picture is not uniformly bright, however. Consumer sentiment readings are dour. Wage growth is no longer keeping pace with inflation, a squeeze felt most acutely by lower- and middle-income households facing higher bills for fuel and groceries. The labor market has been choppy, with the unemployment rate edging up to 4.2%. And housing remains stuck as well, with 30-year mortgage rates back above 7%.

These crosscurrents produced one of the most lopsided sector performances in the U.S. equity markets we have seen in some time. Energy led the S&P 500 with a 17.2% gain as oil surged, followed by information technology (+7.2%), where AI-related demand continued to drive extraordinary earnings growth. Conversely, utilities fell 12.4%, industrials declined 9.7%, and real estate dropped 5.6%. The weakness in utilities is instructive: despite a powerful long-term demand story tied to data centers and electrification, these companies are financed heavily with debt and are often owned for their dividends, making them especially vulnerable when bond yields rise sharply. The same dynamic weighed on small caps, which tend to carry more floating-rate debt; the Russell 2000 gave back a meaningful portion of its hefty second-quarter gain.

International markets were a bit of a seesaw as well. Developed markets eked out a small gain but emerging markets slipped modestly after a remarkable first half. Several of the markets that led in the second quarter reversed sharply, with South Korea falling 9.6% and India declining 5.6%, as semiconductor stocks across Asia corrected and energy-importing economies absorbed the cost of higher oil. China’s Shanghai Composite fell 6.6%. These reversals underscore the point we raised last quarter about the cyclicality of semiconductor-driven rallies, and they reinforce the value of maintaining diversified international exposure.

Within fixed income, the third quarter was the most challenging period in several years. The 10-year Treasury yield rose roughly 85 basis points during the quarter, breaking above 5% in mid-September for the first time since 2007 and closing the quarter at 5.29%. Because bond prices fall as yields rise, longer-maturity Treasuries lost about 8% in the quarter and municipal bonds declined 6.4%. High-yield corporate bonds held up comparatively better, falling 1.8%, helped by their shorter duration and the strength of corporate balance sheets. Our emphasis on high-quality issuers and measured duration did not make portfolios immune to this volatility, but it meaningfully cushioned the impact relative to longer-dated bonds. There is also an important silver lining: yields on high-quality bonds are now at levels last seen before the 2008 financial crisis, which means the income investors earn going forward—historically the most reliable driver of long-term bond returns—is the most attractive it has been in nearly two decades.

Looking ahead, inflation remains the key variable driving economic growth, markets, and corporate profits. Its path depends heavily on what happens in the Strait of Hormuz. The Fed expects PCE inflation to finish 2026 around 3.7% before falling to 2.3% in 2027, with core inflation easing from 3.4% to 2.5%. That path may be plausible, in part because of simple arithmetic: oil prices spiked in March of this year, so beginning next spring the year-over-year comparisons for energy should become considerably more favorable, even if prices stay elevated. The market is currently embedding one additional interest rate increase this year, with rates remaining elevated until inflation is clearly on a path back toward 2%, which may not occur until late 2027.

The range of outcomes surrounding inflation is unusually wide. A durable agreement that reopens the Strait of Hormuz could pull oil prices down quickly, accelerate the decline in inflation, and open the door to interest rate relief sooner than currently expected. Conversely, a further escalation that disrupts Gulf production for an extended period could push oil well above $100, keep inflation elevated, and force the Fed to tighten more than markets anticipate, raising the risk of a stagflationary slowdown in 2027.

The November 3 midterm elections add another layer of uncertainty to markets. Forecast models currently favor Democrats to win control of the House of Representatives, while the Senate appears considerably more competitive. Affordability, particularly energy, food, and housing costs, has become the defining issue of the campaign. Should Democrats win one or both chambers, the result would be divided government in 2027. With the White House retaining veto power, sweeping changes to tax or regulatory policy would appear unlikely, which may reduce the risk of major policy surprises for businesses. At the same time, divided government tends to bring heightened congressional oversight and more contentious negotiations over spending, and industries already in the political spotlight—energy producers and large technology platforms among them—could face greater scrutiny. History suggests that markets often experience heightened volatility in the run-up to midterm elections, and consequently, the 12 months following have been among the stronger periods for equities. Time will tell.

Against this backdrop, our outlook for U.S. equities through the end of the year and into 2027 is constructive but balanced. Corporate earnings growth remains exceptionally strong, valuations have moderated to roughly their historical averages, and the AI investment cycle continues to accelerate. Estimates now project that capital spending by the largest cloud and technology companies could approach or exceed $1 trillion in 2027. Should inflation ease and yields stabilize, we would expect market leadership to broaden beyond mega-cap technology to the many higher-quality companies in areas such as industrials, healthcare, financials, and small caps that lagged meaningfully this quarter.

The risks, however, are equally real. Higher inflation and interest rates leave less room for error to deliver continued corporate profit growth. A renewed oil shock, a sharper slowdown in consumer spending, or a more aggressive Fed would each pose a challenge to current earnings expectations. In addition, market leadership remains highly concentrated in technology, and the AI buildout is increasingly being financed with debt as capital spending outpaces the operating cash flow of even the largest companies. This dynamic warrants close attention given the semiconductor industry’s history of boom-and-bust cycles.

International equities offer a healthy mix of both opportunity and risk as well. Valuations abroad remain more attractive than in the U.S., and a diversified international allocation provides exposure to economies, sectors, and currencies that do not move in lockstep with our own. However, many major international economies—Europe, Japan, India, and South Korea among them—are significant energy importers and are therefore more exposed to a prolonged oil shock than the U.S. In addition, a firmer dollar supported by higher U.S. interest rates could continue to weigh on returns for U.S.-based investors.

In fixed income, we believe the outlook has improved on the margin even as near-term risks persist. Historically, starting yields have been one of the best indicators of a bond’s future return, and today’s yields offer the most attractive income opportunity in nearly two decades. Yet further Fed tightening, persistent inflation, and large federal deficits could push longer-term yields higher still before they stabilize. We therefore continue to favor high-quality issuers and limited duration, while looking for opportunities to gradually extend maturities and lock in higher yields should rates move further. With credit spreads still relatively narrow, we see little reason to reach into lower-quality credit for additional yield. The sharp decline in municipal bonds this quarter has also improved their relative value for investors in higher tax brackets.

Beyond the near-term frictions, we continue to see several long-term investable themes that we believe can create value over the coming decade. The AI buildout is extending well beyond semiconductors into the physical infrastructure required to support it—electrical equipment, cooling, networking, and data center construction. Closely related is power generation and grid modernization: electricity availability has become one of the most significant constraints on AI expansion. We see opportunities across generation, transmission, and the companies that supply them, and this quarter’s sharp sell-off in industrials may create more attractive entry points in some of these businesses. Robotics and automation should benefit as companies seek to offset labor constraints, reshore production, and apply AI to the physical world. In healthcare, innovations aimed at longevity and healthy aging serve a large and growing population of older Americans. And while quantum computing remains at an early and speculative stage, the pace of technical progress suggests that it could become a meaningful opportunity over time; patience and careful position sizing are critical there. We approach each of these themes the same way: by seeking well-capitalized, high-quality businesses with durable competitive advantages, rather than chasing the most speculative names riding a popular narrative.

As we finish the year, we believe market volatility is likely to remain elevated. With an unresolved war in the Middle East, a Federal Reserve in tightening mode, a contentious election, and an equity market that remains heavily concentrated, there is no shortage of potential catalysts for sharp moves in either direction. We will continue to manage portfolios with prudence, emphasizing quality, diversification, appropriate liquidity, and disciplined rebalancing. But volatility is not only a risk to be managed; it is also an opportunity. Periods of market stress frequently push the prices of excellent businesses and high-quality bonds below what we believe they are worth, and we intend to use those moments to thoughtfully initiate or add to positions where we see compelling long-term value. Through it all, we remain committed to what we do best: building and managing portfolios with discipline, patience, and a clear focus on your unique investment objectives. We are grateful for the trust you place in us, and we hope you are able to enjoy the fall season and the upcoming holidays with family and friends. Please reach out with any questions; we always welcome the opportunity to hear from you.

Warm regards,

John, Cam, and team