Rates jump, bonds slump
September equity markets were mixed following a positive August. Rate-sensitive sectors came under pressure, pushing the Dow Jones Industrials sharply lower. Small-cap and dividend stocks fell under the weight of higher interest rates. The S&P 500 was also down. But the tech-heavy Nasdaq bucked the trend with the help of strong AI-related names.

• S&P 500 ↓ 0.5%
• Nasdaq ↑ 1.9%
• Dow Jones Industrials ↓ 4.3%
• Russell 2000 ↓ 4%
• Dividend stocks ↓ 4.7%
• Bloomberg U.S. Aggregate Bond Index ↓ 2.7%

The CBOE Volatility Index (VIX) closed at 16.3, comfortably below the 20 level considered stable (a notable improvement from earlier in the year). The reading masks a turbulent month in the bond market. The 10-year Treasury yield climbed from about 4.75% to 5.29%, its highest level since 2007. The Fed’s rate hike, persistent inflation concerns, and heavy Treasury issuance all drove the move.

Fed surprises with rate hike
At its September meeting, the Federal Reserve voted 12-0 to raise the federal funds rate by 25 basis points to a target range of 3.75% to 4.00%. It was the first increase since 2023 and ended a streak of five consecutive meetings with rates on hold. Fed Chairman Kevin Warsh cited two key drivers: a resilient labor market and persistently elevated inflation, worsened by the rebound in oil prices.

The decision reversed earlier expectations of additional cuts. The Fed’s dot plot points to the possibility of another 25-basis-point increase this year, with officials’ year-end projections ranging from 4.1% to 4.4%. The shift contributed meaningfully to the sell-off in bonds and rate-sensitive equities.

Iran conflict keeps oil elevated
Renewed strikes on shipping and energy infrastructure kept oil prices volatile in September. Brent crude moved from about $95 to above $104 a barrel before settling back on reports of potential negotiations to reopen the Strait of Hormuz. Oil has stayed elevated for an unusually long stretch, and the disruption has now outlasted the market impact of the 2022 Russia-Ukraine conflict.

Energy and defense stocks have broadly outperformed, while sectors sensitive to fuel costs and consumer spending have faced pressure. We are monitoring the situation closely, as oil remains a key swing factor for inflation and the Fed’s policy.

Jobs and inflation data

• August jobs: 162,000 new jobs, well above expectations of 53,000 and the strongest gain since March. Unemployment held at 4.1%.
• September jobs: 29,000 new jobs, with unemployment ticking up to 4.2%. The labor market may be cooling after August’s strong showing.
• August CPI: Headline inflation rose 3.4% year over year, unchanged from July. Core CPI (excluding food and energy) rose 2.4%, down from 2.5%.
• Gasoline: Prices rose 3.9% in August and are up 27.4% from a year ago, reflecting the Iran conflict’s impact on energy markets.

Strong earnings, one-time boosts
In recent years, earnings growth has been the main driver of the strong markets. The second quarter season, which wrapped up in August, delivered some of the strongest headline results:

• 50.4% blended S&P 500 earnings growth was the highest since 2021, boosted by large one-time gains at Alphabet and Amazon, including Amazon’s stake in Anthropic.
• 32% earnings growth (excluding Alphabet and Amazon) was the seventh consecutive quarter of double-digit growth for the index.
• 57% of companies issued positive guidance, well above the 5- and 10-year averages of 41% and marking an improvement from earlier in the year.

Full-year 2026 earnings growth estimates remain strong. Attention will soon turn to the third quarter season, which starts in mid-October, led as usual by the big banks.

Summing it all up
Our outlook for 2026 remains positive, though the Fed’s pivot from cutting to hiking has complicated the path. We are closely watching the new sources of volatility, namely elevated oil prices, a weaker September jobs report, and the prospect of further tightening. Midterm elections traditionally add volatility, and we expect this November to be no exception.

Opportunities remain across a wide spectrum. We are broadening into undervalued, underappreciated assets and expanding into private markets. Dividend stocks have lagged near term given their rate sensitivity, but we view the asset class favorably over a longer horizon, with valuations still attractive.

The market trades at about 19.2 times forward earnings, below the 5-year average and roughly in line with the 10-year average. The economy has proven resilient, though the September jobs data bears watching for signs of a more meaningful slowdown. Leading U.S. companies are well managed, profitable, and innovative, which supports our positive long-term outlook.