BY PAUL BODNAR
CM Wealth CEO, Chief Investment OfficerStrong corporate fundamentals drove the market in the third quarter until the Federal Reserve's Jackson Hole symposium in late August when the Fed chair provided hawkish interest rate commentary. From that point, macroeconomic factors took over, primarily the 10-year Treasury yield and oil prices tied to the Iran conflict. Despite the volatility, equities advanced, with the S&P 500 gaining 2.3% for the quarter.
Rates and Oil Move Higher
Oil prices rose as the Iran conflict continued to disrupt supply, with Brent crude increasing 42% in the third quarter to $103.53 per barrel. Higher energy costs pushed inflation up, prompting more than 80% of developed-market central banks to raise rates in response. The Federal Reserve was among them, raising rates by 25 basis points and moving its target range to 3.75% to 4.0%.
Fixed income markets declined as yields moved higher. The 10-year Treasury yield reached 5.29%, its highest level since 2002. Beyond government borrowing, corporate debt issuance weighed on the market. Tech hyperscalers have issued more than $200 billion in long-term debt this year to finance AI infrastructure. The Bloomberg U.S. Aggregate Bond Index returned -3.5%.
Historically, initial rate hikes introduce several months of market volatility as investors adjust to a new policy path. Equity returns over the following year, however, are typically favorable. In a September 2026 study of the six Fed tightening cycles since 1994, LPL Financial found the S&P 500 was higher 12 months after the first hike 83% of the time, generating an average return of 6.7% and a median return of 10.7%. The Fed typically tightens when the economy is strong enough to absorb higher rates.
Equities: Cheaper Valuations, Weak Breadth
High valuations have been a frequent concern over the past few years. While the major indexes finished the quarter near record highs, valuations compressed. S&P 500 companies are expected to report profits 29.5% higher year-over-year. Because this earnings growth outpaced the modest move in equity prices, the S&P 500's forward 12-month P/E compressed to about 19x by quarter-end. That sits below the 5-year average of 19.8x and roughly in line with the 10-year average of 19.1x.
Beneath the index-level returns, market breadth was weak. Of the 500 S&P companies, 311 closed lower for the quarter. The S&P 500 equal weighted index returned -1.9% in the quarter. Rising borrowing costs pressured capital-intensive sectors. Utilities fell 12.4%, Industrials dropped 9.7%, and Real Estate declined 5.6%, while the small-cap Russell 2000 retreated 7.2%.
Gains were concentrated in a few areas. Energy led all sectors, returning 17.2%. Technology returned 7.2%, supported by a summer recovery in enterprise software and significant gains from select mega-cap AI beneficiaries, including Microsoft (+37.5%) and Meta (+30%).
Internationally, stocks rose 0.6% in the MSCI All Country World Index (ex US). Japan and the UK outperformed, while Europe and semiconductor-heavy Asian emerging markets lagged.
We expect movements in oil prices and bond yields to drive markets in the near term, likely resulting in some volatility. However, we do not see the AI capital expenditure cycle ending. That spending continues to support the broader economy, and we expect rates will stabilize near current levels rather than move materially higher. With corporate balance sheets largely healthy, earnings expanding, and multiples reset to reasonable levels, we remain constructive.
As always, please reach out if you have questions or would like to discuss the quarter.
Paul Bodnar is the chief executive officer, chief investment officer, and managing member of CM Wealth.