Quarterly Performance Update

Earnings, AI Investment Boosted U.S. Stocks in Q3

The S&P 500® Index returned 2.3% for the third quarter, adding to its strong second-quarter rebound. The quarter’s return brought the index’s year-to-date gain to 12.75%, supported by strong corporate earnings and continued investment in artificial intelligence (AI).

Geopolitical uncertainty, higher energy prices, surging Treasury yields and tighter monetary policy created a more challenging backdrop. As the U.S.-Iran conflict continued, rising oil prices contributed to significant gains in the energy sector.

Additionally, U.S. economic data remained resilient, with the final tally of second-quarter growth revised upward to 2.2% (annualized), compared with 2.5% in the first quarter. Consumer spending, investment and exports all contributed to the second quarter’s increase in real gross domestic product (GDP). Meanwhile, the labor market softened modestly.

Performance of Style Indices Varied

Size- and style-specific indices were mixed for the quarter. Large-cap stocks outperformed mid- and small-cap stocks, which declined during the quarter. However, small-cap stocks remain the top year-to-date performers, up nearly 14%. Across the board, the value style outperformed growth stocks.

Large-cap value stocks (Russell 1000® Value Index) rose 2.61% while small-cap growth stocks (Russell 2000® Growth Index) tumbled -9.39%. Plus, highlighting the strength of mega-cap stocks, the S&P 500 Top 50 outperformed, up 3.98%.

Just four of the S&P 500’s 11 sectors posted gains, led by energy, up 17.23%, information technology up 7.2%, health care up 6.46% and communication services up 3.64%. The utilities sector declined the most, down 12.39%.

Fed Hiked Rates for First Time Since 2023

The Federal Reserve’s (Fed’s) unanimous decision to hike rates amid persistent inflation pushed the federal funds target rate to a range of 3.75% to 4%. A solid job market and robust business investment gave the Fed room to raise rates.

Inflation has remained above the Fed’s 2% target for more than five years. While new Fed Board Chair Kevin Warsh didn’t participate in the September dot plot, most Fed officials expect a mild rate-hike cycle.

Non-U.S. Developed Markets Still Lagged Their U.S. Peers

Non-U.S. developed markets slowed, following a rally in the second quarter, lagging U.S. stocks in the third quarter and year-to-date. The MSCI World Ex-U.S. Index rose 0.89%, pushing its year-to-date gain to 10.16%.

How Did European Stocks Perform During the Quarter?

European stocks generally struggled, lagging global peers, amid renewed increases in energy prices, heightened inflation and economic growth concerns. However, the energy sector ended the quarter up 20%.

Eurozone annual inflation jumped to 3.8% by quarter-end — its highest level since September 2023. The European Central Bank (ECB) hiked rates for the second time in 2026, attempting to quell inflation.

U.K. stocks outperformed the broad non-U.S. developed markets index, benefiting from greater exposure to financials, energy and commodity-related sectors.

While headline inflation rose throughout the quarter, the Bank of England held rates steady. However, policymakers said that it is more likely the central bank will need to raise rates if the current volatility persists.

Japan’s stock market also advanced, despite headwinds such as geopolitical uncertainty, persistent inflation and rising yields. The Bank of Japan raised interest rates to the highest level since 1995.

Emerging Markets Stocks Pulled Back in Q3

Following a strong second quarter, emerging markets (EM) stocks (MSCI Emerging Markets Index) returned -0.37%, lagging developed markets stocks. The global semiconductor sell-off in July contributed to the drag of EM stocks. Year to date, EM stocks outpaced developed markets stocks, up 23.38%.

Stocks in South Korea fell, largely due to the country’s semiconductor names, as investors questioned AI valuations and the sustainability of AI capital spending. Stocks in Taiwan posted moderate gains.

Meanwhile, stocks in China, one of the EM index’s largest components, gained during the quarter. Strong export growth and solid performance in the technology and advanced manufacturing industries supported the market.

U.S. Bonds Declined as Treasury Yields Rose

U.S. bonds retreated in the third quarter as Treasury yields moved sharply higher. The Bloomberg U.S. Aggregate Bond Index returned -3.51%, with all its sectors declining.

Within the index, mortgage-backed securities (MBS) and investment-grade corporates logged the weakest quarterly returns, while Treasuries outperformed the index average. High-yield corporates fared better than investment-grade corporates. Additionally, inflation expectations rose, yet Treasury Inflation-Protected Securities (TIPS) underperformed nominal Treasuries. This was due to TIPS having greater sensitivity to rising rates.

Elevated inflation, rising oil prices and a hawkish Fed helped push Treasury yields higher for the quarter. The yield on the 10-year Treasury note ended September at 5.29%, up 82 basis points (bps) from June-end. The two-year Treasury yield rose 71 bps, from 4.20% to 4.91%, and the yield curve steepened.

Economic data offered a mostly positive picture, with continued strength in personal income and spending. Meanwhile, headline inflation, as measured by the Consumer Price Index, remained elevated at 3.4% through July and August. The annual core personal consumption expenditures index, the Fed’s preferred inflation gauge, remained 3% in July and August.

Job growth slowed slightly as employers added 29,000 jobs in September. Downward revisions reduced previously reported July and August job growth by a combined 60,000. Meanwhile, the unemployment rate ticked back up to 4.2% by quarter-end.

How Did Global Bonds Compare With U.S. Bonds?

Government bond yields in Europe and the U.K. rose over the quarter, as inflation concerns, oil prices and tighter central bank policies extended beyond the U.S. Longer-maturity government bonds were among the most adversely affected as yields rose.

The U.S. dollar was volatile but ended the quarter close to its June 30 level. Bloomberg’s dollar-hedged global bond index returned -2.53, outperforming U.S. bonds. EM bonds also declined for the quarter, with local currency-denominated securities generally outperforming EM hard currency bonds. Local bonds outperformed U.S. and global bonds.