Third Quarter 2026 Market Update: Strong Foundations with Shifting Winds
In late September, second quarter gross domestic product (GDP) growth was revised sharply higher to 2.2%, driven primarily by increases in consumer and government spending.
The 10-Year U.S. Treasury yield rose to a 24-year high of 5.3% amid the resilient economic backdrop and inflation holding steady at 3.4%, firmly above the Federal Reserve’s 2.0% target.
Surging interest rates drove a reemergence of concentrated market leadership and mixed equity performance over the quarter, while major equities indices have delivered double-digit percentage returns on a year-to-date basis.
Economic Update
Despite inflationary and geopolitical headwinds, the second quarter U.S. GDP growth estimate was revised upwards to an annualized 2.2%, driven primarily by increased consumer spending. It is also worth noting that estimates suggest technology and AI infrastructure spending made up roughly one third of year-over-year growth[1]. Looking ahead, the Atlanta Federal Reserve’s GDPNow model estimates third quarter real GDP growth at 3.7%, driven by the steady labor market, massive corporate spending on the AI infrastructure buildout, and healthy consumer balance sheets.
Sustained economic growth coupled with sticky inflation drove the 10-year U.S. Treasury yield higher throughout the quarter, which surged to roughly 5.3% at the end of September after the Federal Reserve hiked interest rates for the first time since July 2023. This represents the highest 10-year yield we have seen since 2002.
When it comes to the health of the labor market, unemployment edged up very slightly September. The move was less than many were expecting, yet still a sign of subtle softening. We are in somewhat of a “low hire, low fire” environment. There are less new jobs being created than in the past, although our economy simply does not need the same level of new job creation as we once did to keep the labor market steady. The population is aging, the immigration clampdown has reduced growth in the supply of workers, and productivity is increasing.
With the labor market remaining on steady ground, taming inflation is still the Fed’s main focus. Headline inflation stands at 3.4%, which is firmly above the 2.0% target, and due partly to the sharp rise in energy prices tied to renewed tensions in the Middle East. The Fed’s September rate hike represents a meaningful shift from the rate-cut expectations many investors held earlier in the year. Barring a reversal in the labor market or any economic shocks, the inflation scenario signals a higher probability of more monetary policy tightening in the fourth quarter via additional rate hikes.
Market Update
Equities
Following a uniquely strong first half of the year for much of the stock market, third quarter performance was mixed as rising interest rates weighed on investor sentiment. The S&P 500 index, representing large cap equities, outperformed in the quarter, posting just over a 2.0% total return. Despite positive performance of the index, the majority of S&P 500 companies actually underperformed the overall index in the quarter. This phenomenon occurs due to the index being capitalization weighted. In other words, the weighting of each company in the index is proportional to its total market market value.
The 10 largest S&P 500 companies (mostly technology and AI related) now make up a whopping 40% of the index, which translates into a small handful of companies contributing the majority of the S&P 500’s positive performance over the quarter[2]. While many investors assume the S&P 500 index to be diversified, today’s level of concentration reinforces the case for investment exposure outside of just U.S. large cap equity indices and is a theme we have positioned our client’s equity portfolios around.
S&P 500 companies are collectively on pace to deliver a stellar 29% year-over-year earnings growth in the third quarter, marking the third consecutive quarter of earnings growth above 25%[3]. Much of this growth, however, is coming from the technology and energy sectors. If you remove those sectors, S&P 500 earnings growth looks more like 15% - 19%. More notably, earnings growth of U.S. small cap equities is expected to be higher than large caps in both 2026 and 2027 [4].
Price-to-earnings (P/E) valuation multiples of equities across all market capitalizations compressed throughout the quarter. While technology and AI-related multiples remain elevated historically speaking, they are generally supported by sky-high earnings growth. Going forward, the question is whether technology sector earnings growth can remain strong enough to continue supporting their elevated valuations.
Conversely, small and mid cap equity valuation multiples remain well below their historical averages, and small caps are trading at a 25% discount to large cap equities. When interest rates rise, small cap companies tend to underperform large caps over the short-term, as smaller companies are perceived to be more exposed to external financing needs and more vulnerable to higher borrowing costs. Yet, historical evidence shows that over the longer term, small cap equity performance is more closely tied to earnings growth.
Fixed Income
Fixed income had a difficult third quarter, as the combination of sticky inflation, spiking oil prices, and a wave of corporate borrowing to fund AI infrastructure all pushed bond yields higher. The Fed’s rate hike in September added further pressure. As a result, Treasury yields climbed to some of their highest levels in decades. Since bond values move inversely to yields, rising rates translated into losses for longer-dated bonds. The Barclays US Aggregate Index, a proxy for investment grade U.S. bonds, delivered a negative 3.9% return over the third quarter.
Not all corners of the fixed income market felt impacts of rising rates equally though. The shorter a bond’s duration, the less sensitive its value is to interest rates fluctuations. Conversely, a holder of a 20-year bond felt much more pain. Investors that purchased long-dated bonds in a lower interest rate environment are now in a "sticky" situation of having to either sell at a loss, or hold the lower-yielding bonds until maturity to recoup par value.
As discussed in prior updates, we continue to favor shorter and intermediate-term bond strategies pricesely because of this, along with long-term interest rate uncertainty remaining elevated. More specifically, we believe some of the most attractive opportunities for fixed income investors today exist in the U.S. Treasury market. The yields on 2-year and 5-year Treasuries stand at 4.8% and 5.0%, respectively. This presents an opportunity to earn meaningfully higher income on short-term bonds than what could have been achieved in recent history.
Corporate bonds generally offer higher yields than comparable Treasuries, as they entail more risk. However, today's incremental yield (also known as credit spread) is historically tight. With investment grade corporate bond credit spreads at just over 0.8%[6], we believe corporate bonds are inadequately compensating investors for the additional risk.
Looking Forward and Parting Thoughts
When we experience extended periods of strong equity performance like we have the past several years, there is an important distinction to be made between speculation and valuations being justified by fundamentals. Earnings growth, rather than valuation multiple expansion, is likely to drive equity returns going forward with AI related capital expenditures and productivity gains anchoring fundamentals.
The steady labor market and resilient economic growth are promising fundamentals underpinning the current market. While we do not believe the recent shift in Fed monetary policy changes that underlying picture, inflation is still a risk and longer term interest rate uncertainty remains.
While there is an opportunity to earn a higher yield on shorter-term fixed income, it does not necessarily mean it is the most prudent investment for everyone. It is certainly attractive for some investors depending on their unique needs and circumstances, but it is not accretive for growth-oriented investor portfolios with longer time horizons. After all, the reason we take risks is for additional reward.
Over the long run, investors are rewarded more for being owners than they are for being lenders. In other words, owning equities has historically delivered far greater long-term returns than owning bonds, with the cost being interim volatility. History tends to rhyme rather than repeat itself, yet there have been only three instances since 1929 that the stock market has delivered negative returns over a 10-year period.
We design and manage our client's portfolios around their goals, to align with their time horizon and risk tolerance, and to be resilient across a range of different outcomes.
As always, we welcome the opportunity to discuss this letter, year-end planning opportunities, or any changes in your personal financial situation.
Sincerely,
The RISE Team
Footnotes
[1] Source: ING, How much is AI contributing to US economic growth?, August 19, 2026.
[2] Microsoft, Nvidia, Apple and Meta alone contributed more than 200% of the index’s entire gain in Q3, while the majority of companies detracted. Source: Citadel Securities, October: The Q4 Reload.
[3] Source: FactSet, Earnings Insights, October 2, 2026.
[4] As measured by Russell 2000 index. All companies without brokerage analyst coverage are excluded. Source: FactSet, October 1, 2026.
[5] Source: FactSet. Past performance is no guarantee of future results.
[6] FRED, ICE BofA US Corporate Index Option-Adjusted Spread, September 30, 2026.
Disclosure
RISE Investment Management, LLC ("RISE" or "RISE Investments") is an investment adviser registered under the Investment Advisers Act of 1940. Registration of an investment adviser does not imply any level of skill or training. This publication is solely for informational purposes and past performance is not indicative of future results. Any description of products, services, and performance results of RISE contained in this publication are not an offering or a solicitation of any kind. No advice may be rendered by RISE Investments unless a client service agreement is in place. Advisory services are only offered to clients or prospective clients where RISE Investments and its representatives are properly licensed or exempt from licensure. All of the information in this publication is believed to be accurate and correct as the date set forth. RISE does not have or accept responsibility or an obligation to update such information. Please note, this article is for education purposes and should not be treated as tax or legal advice. This article is not a substitute for legal or tax advice from your professional legal or tax advisor.