Quarterly Performance Update

U.S. Stocks Delivered Strong Third-Quarter Returns

The S&P 500^® Index reached a series of record highs, ending the quarter up 8.12%. Investors seemingly overlooked new and lingering challenges, focusing on solid second-quarter earnings results, resilient economic data and growing expectations for Federal Reserve (Fed) easing.

Ongoing trade disputes, persistent inflation, mounting labor market worries and a looming government shutdown were no match for the market’s momentum. Even a massive downward revision in a year’s worth of non-farm payroll data didn’t curtail market optimism. Instead, news that the government overstated job growth by nearly 1 million jobs (for the 12 months ended in March) further fueled rate-cut expectations.

Small-Cap Stocks Outperformed

The stock market’s third-quarter rally was widespread, with all key size and style indices advancing. Small-cap stocks outperformed large- and mid-cap stocks, while style indices were mixed.

Small-cap value stocks (Russell 2000^® Value Index) were top performers, up nearly 13%. Mid-cap growth stocks (Russell Midcap^® Growth Index) were the weakest, gaining nearly 3%.

Ten of the S&P 500’s 11 sectors posted gains, led by information technology, up 13%, and communication services, up 12%. Consumer staples underperformed, down more than 2%.

Fed’s Shift in Focus Led to the Year’s First Rate Cut

The Fed turned its attention from persistent inflation to signs of labor market weakness, prompting the first rate cut since December 2024. The Fed lowered its short-term interest rate target by a quarter-point on September 17. The federal funds rate now stands at a range of 4% to 4.25%.

Amid the significant downward revisions to job growth data, the Fed indicated rising unemployment represents a bigger economic threat than stubborn inflation. Most policymakers hinted they may cut interest rates another half-point by year-end.

Non-U.S. Stocks Rallied but Lagged the U.S. Market

Non-U.S. developed markets stocks (MSCI World Ex-USA Index) posted another quarterly gain, returning 5.3% in U.S. dollar terms. European stocks underperformed the index, largely due to a sell-off in Germany, a top performer in the second quarter. Stocks in France rose but lagged the index amid political instability.

U.K. stocks outperformed the index. An August interest rate cut from the Bank of England aided investor sentiment, while a weaker pound helped boost export earnings. The resilient global economy and solid performance from the basic materials and technology sectors further supported the rally.

The Bank of England cut rates by 25 basis points (bps) even as inflation rose to 3.8%, well above the central bank’s target. The European Central Bank (ECB) held interest rates steady in the quarter, as inflation remained close to the ECB’s 2% target.

Trade Deal with U.S. Aided Stocks in Japan

Japan’s stock market outperformed the index, benefiting from a U.S. trade deal that lowered U.S. tariffs on nearly all Japanese exports. Additionally, a weaker yen lifted export earnings, while resilient economic data, slower inflation and ongoing corporate governance reforms further supported gains.

China’s Performance Lifted EM Stocks

Emerging markets (EM) stocks (MSCI Emerging Markets Index) returned 11% in U.S. dollar terms, outpacing developed markets, largely due to gains in China. A strong rally in China’s technology sector, driven by continued robust artificial intelligence spending and policy support for China’s chip makers, helped fuel the results. Meanwhile, easing trade tensions with the U.S. and the government’s ongoing campaign to restore corporate profitability and innovation supported the broader market.

Strong stock market performance in Taiwan, another beneficiary of technology sector strength, also helped drive emerging markets’ outperformance.

U.S. Bonds Logged Their Third Straight Quarterly Gain

Returns in the U.S. bond market were broadly positive in the third quarter. The Bloomberg U.S. Aggregate Bond Index gained 2%, as all index sectors advanced, led by the outperforming investment-grade corporate and mortgage-backed securities (MBS) sectors.

Amid resilient growth and persistent inflation, Treasury yields were volatile early in the quarter, but they ended the three-month period lower overall. Labor market concerns and growing expectations for Fed easing generally fueled the decline. The two-year Treasury yield declined 10 bps to 3.62%, while the 10-year yield fell from 4.23% to 4.15%. The yield curve between two and 10 years steepened slightly.

The annual headline Consumer Price Index (CPI) rose from 2.7% in July to 2.9% in August, its highest since January. Core CPI remained unchanged at 3.1%, and the annual core Personal Consumption Expenditures Price Index, the Fed’s preferred inflation gauge, held steady at 2.9%, well above the Fed’s 2% target.

Non-U.S. Bonds Lagged U.S. Bonds

Government bond yields in the U.K. and Europe rose for the quarter. Global bonds advanced modestly but underperformed.

U.S. bonds. The U.S. dollar appreciated versus other currencies, and Bloomberg’s dollar-hedged global bond index returned 1.2% for the quarter.

EM bond returns also advanced. Amid U.S. dollar strength, U.S.-dollar-denominated EM securities outperformed local currency-denominated EM securities.