Financial market returns became concentrated in the third quarter; U.S. large-capitalization (cap) equities were the primary driver of positive performance. That said, global economic data broadly surprised to the upside during the third quarter. However, the positive fundamental data was overshadowed by interest rate increases from major central banks, including the Federal Reserve (Fed). Financial conditions tightened and long-term bond yields rose in the U.S., with U.S. Treasury yields reaching their highest levels in nearly 20 years. The ongoing conflict in the Middle East added further volatility during the quarter as U.S. diesel prices reached an all-time high.
Which asset classes led in Q3?
U.S. large-cap equity (2.30%)
Our thesis: U.S. large-cap equities are the long-term growth and innovation engine of public equities given their sustainable, high-quality fundamental characteristics.
Quarter recap: U.S. large-cap equities outperformed as companies in the Information Technology sector linked to artificial intelligence (AI) innovation with resilient earnings growth held up amid rising bond yields and macroeconomic uncertainty.
Looking ahead: We expect U.S. large-cap equities to continue to exhibit strong earnings growth and profit margins given their robust technology sector exposure.
Developed international equity (0.69%)
Our thesis: Growth expectations are improving and developed international exposure offers long-term diversification benefits in portfolios.
Quarter recap: Developed international equities were led by equities in Japan, supported in large part due to local currency weakness, as well as commodity stocks in Australia and Canada.
Looking ahead: Infrastructure and defense spending plans are expected to be a tailwind that bolsters economic activity, though continued reliance on imported energy remains a risk.
Emerging market equity (-0.30%)
Our thesis: Emerging markets (EM) contribute more than half of global GDP, despite their modest weighting in the MSCI All Country World Index. Long-term secular and economic growth themes support our positive view of the asset class.
Quarter recap: EM stocks were approximately flat as underperformance in semiconductor stocks in South Korea was offset by positive returns from commodity exporting countries.
Looking ahead: We remain favorable on EM given the strong earnings outlook, technology innovation in Asia and fading global trade policy concerns. However, high concentration in semiconductors remains a source of volatility, in our view.
Which asset classes lagged in Q3?
U.S. small-cap equity (-7.23%)
Our thesis: Elevated interest rates can be challenging for U.S. small-cap equities, but we believe they will benefit from their U.S.-centric revenue exposure over the long term.
Quarter recap: In addition to headwinds from the rising interest rate environment, the Russell 2000 index reconstitution in June removed some of the leading tech stocks from the index, contributing to material sector underperformance relative to the index’s mid- and large-cap counterparts.
Looking ahead: Near-term inflation and elevated borrowing costs could remain headwinds, but we believe small-cap equities should benefit from positive earnings trends and could benefit disproportionately from AI-related productivity gains.
U.S. mid-cap equity (-6.36%)
Our thesis: The current inflation backdrop is challenging for U.S. mid-cap equities, but we believe they can benefit from U.S.-centric revenue exposure over the long term.
Quarter recap: Despite a strong second-quarter earnings season, headwinds from rising energy costs, elevated inflation and rising interest rates weighed on returns.
Looking ahead: In our view, near-term inflation could be a challenge, but mid-cap equities should benefit from relatively attractive valuations and improving earnings.
Core fixed income (-3.51%)
Our thesis: Core fixed income tends to serve as the primary ballast in multi-asset portfolios given its broad diversification across investment grade, U.S. Treasury, corporate and securitized markets.
Quarter recap: Core bonds sold off as the Fed began a new interest rate hiking cycle and bond yields rose sharply in September.
Looking ahead: Over the long term, core fixed income can provide stability and income in portfolios and help to dampen volatility. In our view, current yields offer reasonable compensation despite increased near-term inflation expectations.
Index Performance
| 3-mo | Sept | Aug | July |
U.S. Equity |
|
|
|
|
Russell 3000® | 1.41 | -0.84 | 2.74 | -0.47 |
S&P 500® | 2.30 | -0.35 | 2.72 | -0.06 |
S&P 500 Growth® | 3.44 | 1.95 | 3.27 | -1.75 |
S&P 500 Value® | 0.90 | -3.10 | 2.08 | 2.01 |
S&P MidCap 400® | -6.36 | -4.22 | 0.15 | -2.38 |
Russell 2000® | -7.23 | -5.25 | 0.98 | -3.03 |
International Equity |
|
|
|
|
MSCI ACWI Ex USA IMI | 0.69 | -2.43 | 3.01 | 0.17 |
MSCI World Ex USA IMI | 1.17 | -3.25 | 2.52 | 1.99 |
MSCI EM IMI | -0.30 | -0.72 | 4.08 | -3.51 |
Fixed Income |
|
|
|
|
Bloomberg U.S. Aggregate Bond | -3.51 | -2.61 | 0.39 | -1.30 |
Bloomberg U.S. Corporate High Yield | -1.82 | -2.52 | 0.97 | -0.25 |
Bloomberg EM USD Aggregate | -3.46 | -2.91 | 0.74 | -1.30 |
Bloomberg Municipal | -6.35 | -4.36 | -0.23 | -1.85 |
Bloomberg U.S. Treasury Bill 1-3mo | 0.93 | 0.30 | 0.29 | 0.34 |
As of 9/30/2026. Source: Morningstar
