Alas, likely to nobody’s great surprise, the peace talks failed to hold, and we exit Q3 with a much different perspective. Brent crude once again sits above $100 per barrel. This has pushed the more practical concern for consumers, namely gasoline prices, back to levels last seen during the inflationary surge of 2022. At an average price across the country of $5.30 per gallon, this has naturally captured the attention of households, politicians, and financial markets alike. These price level effects have served as a giant first domino in a chain of economic and financial market developments over recent months.

The Consumer Price Index (CPI) sat at 2.4% year-over-year (YOY) for both January and February, just prior to the conflict. By May, this had increased to 4.3%. Thankfully, the most recent three prints have been slightly better, with August’s version coming in at 3.4%.

The direct impact from energy prices has been impossible to miss. Since the onset of the conflict, the energy component of CPI has posted YoY increases of anywhere from 12.5% to 23.5% in the six monthly reports since the war’s inception. Core CPI, which excludes the volatile areas of food and energy, has trended slightly lower this quarter, with August producing a 2.4% YoY number, roughly the same as that in February.  As such, there does not yet appear to be broad spillover effects. That said, the August CPI report came in slightly hotter than expectations, helping to cement the Federal Open Market Committee’s (FOMC) decision to hike rates at its September meeting.  Core PCE, their preferred metric, sits at 3.0% YoY for August, further adding to the concerns over pricing pressures. 

While we are talking about bad news, another very clear area of economic weakness lies in the housing market. Rates have been on a steady and aggressive march higher over the course of the quarter, pushing the average 30-year mortgage rate above 7%. At the same time, home prices have, in general, continued to climb. This, along with ancillary prices on things such as insurance and maintenance, and an uncertain economic backdrop, has created a challenging environment for housing activity.  For just one metric to illustrate this, from 2015-2019, existing home sales averaged 5.4M units per month.  Since the beginning of 2024, this number is only 4.0M units. 

Housing is just one notable example of the affordability issues that are weighing on lower-income consumers. As such, it is no surprise that sentiment continues to lean meaningfully negative. The University of Michigan sentiment survey is very near all-time lows, and recently the Conference Board Consumer Confidence measure for September was the lowest level in over a decade. 

In a vacuum, when you combine all the above, one could be forgiven for coming away borderline depressed and expecting to see a significant economic slowdown. However, economic data often has a way of humbling expectations. We just received the final report for Q2 GDP at 2.2% quarter-over-quarter annualized, and the underlying metrics related to primary end demand were significantly more robust than even that strong number would indicate. More impressively, the Atlanta Fed is currently predicting a strong 3.7% number for the just ended third quarter So, economic growth appears to be, if anything, strengthening in the face of the negative sentiment and inflation pressures. 

A significant portion of this is naturally due to intense investment in AI, but the underlying core demand functions also remain remarkably robust.  Retail sales figures were very strong for August after a rare lackluster print for July.  Real personal spending (personal spending minus CPI inflation) has increased in 26 of the last 32 months, with the recent September number the highest since March of 2025.  Other high-frequency indicators (e.g., restaurant activity, TSA checkpoint passenger travel numbers, hotel occupancy rates) tell a similar tale of American consumers continuing to go out, do things, and spend money.

A major reason consumers continue to power through the collective anxiety is a familiar refrain: the labor market remains resilient.  August produced an extremely strong report with over 130K jobs added, along with upward revisions to the previous months. Of course, labor market data is always heavily subject to revision, and the fresh-off-the-press report for September was softer at only 29K jobs added.  Weekly jobless claims are extremely low by historical context, at a four-week moving average of just over 200K, and continuing claims have steadily gone down since late last year. The unemployment rate, which rose to 4.2% with the September report, still indicates a labor market that is likely very close to practical full employment.

Thus, at the risk of sounding like a broken record, the U.S. economy still fits quite comfortably within the highly technical economic classification of “okay”.  Compared to three months ago, we probably feel a bit worse about inflation, but a bit better about growth and the labor market.  Further, as much as economists like to focus on forecasts, estimates, and the inevitably breathless reactions to surprises in both directions, we continue to believe that the geopolitical tail is very much wagging the economic dog. Should the conflict in the Middle East de-escalate (again, but preferably for real this time), we believe inflation will be able to retreat lower again. Should that occur while the labor market remains firm, growth can continue at a reasonable pace.  That remains our baseline outlook.  Still, given the degree to which geopolitical events have repeatedly defied forecasts over the last several years, we offer that outlook with an appropriate amount of humility. In today’s environment, certainty remains one of the scarcest commodities in the world.​

Wars, higher rates, higher gas prices, new tariffs, “catastrophic or existential risks to humanity” (to quote Anthropic’s IPO prospectus under Risks); whatever has been thrown at this equity market has been firmly rejected as a reason to sell off. While markets experienced some mild volatility in late July and mid-September, the S&P 500 ended the quarter approximately 2% from all-time highs. The 30%+ earnings growth posted in the first half of the year could reasonably explain some, or perhaps all, of stocks’ resilience. A closer look beneath the index’s surface, however, tells a different story. While the S&P 500 is within 2% of its 52-week and all-time highs, the average stock is more than 20% below its own 52-week high, and over 40% of index constituents are down more than 20% from their highs. I would note that over the past quarter, the S&P 500 outperformed the equal-weight S&P 500 by approximately 420 basis points (or 4.2%), most of which occurred in the past 30 days. This highlights that the broader market has incurred more damage from some of the headwinds mentioned above. Let’s examine the returns for the period for more insights.

For the quarter, the S&P 500 rose 2.3% and is up 12.7% Year-to-date (YTD). Interestingly, in the month of September, 75% of the S&P was down for the month despite the overall index rising slightly. Small-cap stocks came back to earth during the quarter, negatively impacted by rising interest rates, falling 7.9% (as measured by the S&P 600). For the YTD period, they remain solidly positive, up 14.2%, through 9 months. Performance outside the US lagged as Emerging Markets were affected by pullbacks in Taiwan & South Korea while a stronger US Dollar also dented returns. Developed International Markets were just above breakeven at 0.9% for the quarter (as measured by the EAFE Index) while Emerging Markets (EM) were on the other side of 0%, falling 0.4% for the latest period (measured by the MSCI Emerging Market Index). On a YTD basis, these two indices are up 10.9% and 23.5%, respectively. Putting the US and International Markets together, the MSCI All-Country World Index (ACWI) finished positive for the quarter, 1.7%, and is higher by 13.4% YTD. The equal-weight ACWI lagged, finishing down 0.8% for the quarter but up 7.7% for YTD. This YTD spread between ACWI and equal-weight ACWI highlights additional evidence of the discussion above regarding market breadth.

From a sector perspective, 4 of 11 economic sectors of the market were positive for the period, and only 4 of 11 outperformed the broader market (S&P 500). Given the move in oil, it was no surprise that Energy finished on top (+17.2%), followed by Technology (+7.2%) and Healthcare (+6.5%). This was quite a finish for Tech stocks after finishing at the bottom in the first month of the quarter. Communication Services (+3.6%) was the other positive sector. After starting strong, Financials (-0.1%) slipped into the red on the final day of the quarter after leaking lower over the last month. The bottom performers were highlighted by rate sensitive sectors like Utilities     (-12.4%) and Real Estate (-5.6%) but also economically cyclical areas such as Consumer Discretionary (-5.1%) and Industrials (-9.7%). Year-to-date, the return backdrop narrowed considerably. While 8 of 11 sectors are positive, only 2 of 11 are outperforming the market. Energy (+40.3%) and Technology (+28.4%) are on top, while Utilities (-5.8%) and Consumer Discretionary (-5.7%) occupy the basement. Healthcare, Industrials and Materials are also worth mentioning on the positive side, up between 8-10% YTD.

Breaking down the factor performance during the most recent quarter, it was a tale of two halves. The first month saw “risk-off” factors such as Value and Dividends work well, with broader performance reflected in Small Size along with a sharp reversal in the Momentum trade that dominated 2Q26. This playbook was flipped on its head in the last two months of the quarter as the market became significantly narrower with Size dominating, particularly in September, along with more “risk-on” factors such as Growth and Momentum. For our strategies, this factor backdrop again provided mixed influences. The Large-cap strategy had a solid absolute return for the period, but relative performance faded as market returns narrowed. The Dividend & Income strategy tracked the factor rotation discussed above, starting out strong in July but ending roughly flat for three months as money rotated from Value to Growth. Relatively the strategy performed very well. Small/Mid-cap also started strongly before fading but posted strong relative performance. Finally, our ETF strategies witnessed similar volatility in absolute and relative performance but remain ahead of benchmarks YTD.

To return to Coach Lombardi’s question, what’s going on out here depends on your point of view.  On the one hand, you could say that the overall market is holding up as the average stock languishes sets the stage for a recovery from a broader universe. Progress in the Middle East, for example, could unlock that scenario. On the other hand, a narrowing of breadth in market returns creates a false sense of calm before a move lower by the larger names and/or further deterioration under the surface. We have seen this outcome in past episodes of such a backdrop. Seasonally, we are entering a positive time of year, especially during mid-term election cycles. Earnings should continue to be good, but the rate of change is expected to moderate as we move into 2027; and in this business, to quote Liz Ann Sonders from Charles Schwab, “better or worse matters more than good or bad.” I believe geopolitical developments—and the related moves in interest rates—will have the greatest influence on equity performance in the fourth quarter.

As is typically the case, the 2-Year Treasury yield is ahead of the Federal Reserve, finishing the quarter 89 basis points (bps) higher than the top end of the Fed Funds Rate at 4.89%. Additionally, this is 72 and 142 bps higher than the yield at the start of the quarter and year, respectively, producing total returns of +0.24% and +0.26%. These returns would be much lower without the higher coupon environment offsetting the drop in price. The 10-Year Treasury fared much worse as it reached levels not seen in two decades. Its yield ended the quarter at 5.28%, which is 81 and 111 bps higher on the quarter and year, respectively. This results in returns of -5.17% and -5.15%. This is one of the worst quarterly returns for the 10-Year going back 40 years, especially when compared to periods before the Federal Reserve employed a zero-interest rate policy from the 2008 Financial Crisis.

Corporate bonds underperformed their Treasury counterparts as a move higher in the spreads at which they trade over Treasuries materialized at the end of the quarter. The yield-spread over Treasuries of the Bloomberg Intermediate Corporate Index finished the quarter at 73 bps which is still quite low historically. The overall yield of this index is 5.81%. That is 90 bps higher than the start of the quarter and 140 bps higher than the beginning of the year. This produced returns of -2.13% and -1.57% for the quarter and year periods, respectively. Even in the face of higher rates, issuance of corporate debt remains robust. Paramount successfully issued $52 billion of debt to fund its purchase of Warner Bros after receiving $109 billion in orders. We continue to think that corporate bond spreads will drift higher as geopolitical conflicts persist and the Fed seeks to cool inflation.

The municipal market had a rough quarter. In fact, September was the worst monthly return for intermediate municipal bonds as measured by the Bank of America Merrill Lynch 4-6 Year Index that dates back to 1997. Further, the quarterly return of -3.44% was second only to the first quarter of 2022 as we moved away from sub-1% interest rates in the recovery out of the Covid period. The yield ratio to Treasuries has moved higher to nearly 80% which, when coupled with the highest absolute yields since 2008, represents extremely good relative value. Unlike the federal government, local municipalities must run balanced budgets and defaults have been rare.

We have been early in adding duration to our fixed income portfolios, but we continue to like rates at these levels. For the most part, we are in-line with the benchmark duration and new additions to the portfolios are in the government bond sector. We will be watching the midterm election and any potential policy changes as well as budgetary proceedings around the appropriations bill deadline in early December.

The information contained within has been obtained from sources believed to be reliable but cannot be guaranteed for accuracy.  The opinions expressed are subject to change from time to time and do not constitute a recommendation to purchase or sell any security nor to engage in any particular investment strategy. Investment Advisory Services are offered through Greenwood Capital Associates, LLC, an SEC-registered investment advisor.