The Power of Resolve: Navigating a Higher-Rate Bull Market

Key Takeaways

• Q3 delivered positive but narrow equity returns. The S&P 500 and Nasdaq advanced modestly, while the Dow and small caps lagged as higher rates favored durable large-cap earnings.
• The Fed returned to tightening. Under new Chair Kevin Warsh, the FOMC raised rates 25 basis points in September, its first hike since 2023 as inflation remained above the 2% target.
• Iran remained the dominant geopolitical and inflation risk. Renewed conflict and disrupted energy routes pushed oil sharply higher, pressuring consumers, inflation expectations, and bond markets.
• Interest rates reset higher. The 10-year Treasury yield rose materially during the quarter, creating near-term valuation pressure but improving forward income opportunities in fixed income.
• The bull market remains intact but more selective. Strong earnings and resilient activity support equities, even as policy, election, and geopolitical uncertainty argue for quality and diversification.
• Q4 could reward patience. A possible December rate hike and the midterm elections may keep volatility elevated, but markets could rally as uncertainty clears.

Third Quarter 2026 Recap: Resilience Meets Restriction

Resilient growth, with new constraints: The third quarter showed that the economy and corporate earnings could continue to hold up under pressure. That resilience kept the bull market moving forward, but higher oil prices and renewed Federal Reserve tightening slowed momentum and left market gains concentrated in a smaller group of companies.

A more assertive Federal Reserve: Under Chair Kevin Warsh, the Fed raised interest rates by 25 basis points in September, bringing the target range to 3.75%–4.00%. The unanimous decision marked a clear shift from patience toward a firmer response to inflation.

Inflation remained too high: Price pressures stayed above the Fed's 2% goal as higher energy costs and steady consumer demand kept inflation elevated. As a result, future policy decisions will depend heavily on whether inflation cools without a meaningful weakening in employment or growth.

Conflict in Iran lifted energy costs: Renewed hostilities and disruption around the Strait of Hormuz pushed crude oil prices sharply higher. The increase reduced household purchasing power, raised costs for businesses, and added to inflation concerns—giving the Fed another reason to remain cautious.

Equity gains were modest and uneven: The S&P 500 and Nasdaq advanced during the quarter, while the Dow and Russell 2000 declined. Large growth companies remained in favor and energy stocks benefited from higher oil prices, but narrower participation and elevated valuations left markets more sensitive to setbacks.

Higher yields created both pressure and opportunity: Treasury yields rose sharply as investors reduced expectations for rate cuts and considered the possibility of further tightening. That move weighed on core bonds in the near term, but it also improved the longer-term income potential available to fixed-income investors.

Midterm elections: The November 3 midterm elections are likely to add another layer of uncertainty as investors consider the future balance of Congress and the implications for fiscal policy, regulation, trade, taxes, and government spending. History suggests that the period surrounding the vote is often volatile but can also mark an important transition: since 1932, the S&P 500 has averaged roughly 5.8% in midterm years but approximately 16.3% during the following 12 months, as uncertainty recedes and investors refocus on fundamentals. Longer-term analysis similarly shows that U.S. equities have historically begun to rally about one month before midterm elections as polling clarifies the likely outcome. The current cycle entered the election season from a position of relative strength, with U.S. stocks up approximately 12% through September, an above-average midterm year. A divided government could be interpreted constructively if it reduces the likelihood of abrupt legislative changes and constrains policy extremes, although budget negotiations and fiscal deadlines would remain risks. Once the result is known, clearer policy boundaries—combined with resilient earnings—could support a year-end rally, while investors should remember that election-cycle averages are historical tendencies rather than guarantees.

Risk Framing: The fourth-quarter outlook is constructive, but it is not without meaningful risks. The sharp Q3 repricing illustrates the stakes: the 10-year Treasury yield rose approximately 82 basis points during the quarter to 5.29%, crude oil gained 30%, the Russell 2000 declined 7.5%, and rate-sensitive sectors such as real estate and utilities were among the weakest performers. These moves show how another oil spike, persistently elevated inflation, a more aggressive Fed, or disappointing earnings could tighten financial conditions and challenge equity valuations. Higher borrowing costs may expose weaker balance sheets, while geopolitical or election-related shocks could temporarily reduce liquidity and risk appetite. At the same time, the S&P 500 and Nasdaq still produced positive Q3 returns, credit risk remained contained, and projected S&P 500 earnings growth approached 30%, indicating that volatility has not yet become a broad deterioration in fundamentals. The key distinction is whether a pullback reflects temporary uncertainty or a lasting weakening in profits, credit conditions, and economic activity. As long as earnings remain resilient and systemic stress is limited, market weakness may provide opportunities to add exposure gradually rather than a reason to abandon long-term allocations.

Portfolio Implications

• U.S. equities: Maintain a constructive allocation; favor companies with durable earnings, pricing power, strong balance sheets, and exposure to productivity-enhancing investment.
• Market breadth: Add selectively to cyclicals and smaller companies if yields stabilize and earnings participation broadens.
• Treasuries: Use higher yields to rebuild income, favoring a barbell strategy that captures higher yields while retaining flexibility if inflation remains volatile.
• Municipals: Highlight improved tax-equivalent income and disciplined credit selection after the rate-driven repricing.
• Credit: Prefer higher-quality issuers and avoid reaching for yield where spreads provide limited compensation for downside risk.
• Diversifiers and liquidity: Preserve capacity to rebalance during election, Fed, or geopolitical volatility.