The third quarter was a study in contrasts. On the surface, the S&P 500 extended its gains to a new record high, but the picture underneath was more uneven. A renewed flare-up in Iran pushed oil prices and inflation higher, sending bond yields sharply higher and prompting the Federal Reserve’s first rate hike in three years. The result is a market divided between a powerful earnings engine and mounting pressure on the everyday consumer.
The bright spot remains corporate profits. S&P 500 earnings have grown annual growth of more than 20% for three straight quarters, an exceptional run by historical standards. Notably, earnings rose far faster than stock prices, meaning the market has become less expensive even as it rallied. The broader economy has also proven resilient with healthy GDP growth and an employment picture that remains broadly stable despite some mixed signals. Business activity has accelerated to its fastest pace in more than five years.
Much of this strength continues to come from AI. Demand for data center capacity shows no sign of slowing, and chip shortages have given semiconductor companies remarkable pricing power. Adoption is also accelerating among both businesses and consumers. The narrative around who wins and loses from AI also continues to evolve. Software stocks, which sharply sold off earlier this year on fears of AI disruption, staged a meaningful rebound as those fears have yet to materialize. At the same time, AI “agents” capable of acting on a user’s behalf are causing questions to develop in new areas such as travel booking, banking, and subscription services.
Against these positives, the Iran conflict reemerged as headwind after oil prices had drifted lower through the summer amid hopes for a diplomatic resolution. Renewed strikes stalled negotiations and sent crude back above $100 per barrel. This coincided with new tariffs further straining supply chains. Collectively, these developments raised inflation expectations causing the Fed to raise interest rates in September — its first increase since 2023. Other central banks have moved similarly, contributing to a global rise in bond yields. While this weighs on bond prices near-term, new bond investments now offer some of the most attractive yields in 20 years.
Higher rates and prices are not felt equally, however. The “K-shaped” economy became more pronounced this quarter, as rising costs for fuel, borrowing, and everyday goods weigh most on lower- and middle-income households. Consumer confidence fell to record lows, with consumer stocks largely lagging the broader market. Actual spending has held up better than sentiment would suggest, though partly by households drawing down savings. The divergence showed up in the market itself: while a handful of large AI-related companies carried the index higher, roughly three-quarters of S&P 500 stocks declined in September — a reminder that the headline index does not always reflect the average stock.
Looking ahead, the path of inflation, interest rates, and the situation in Iran will be the key variables to watch. A durable resolution would likely ease energy prices and yields, while escalation would prolong the current challenges. The upcoming earnings season will be important in confirming that corporate strength remains intact, as will the question of whether AI investment is generating an adequate return. November’s midterm elections may add another layer of headlines to monitor.
For investors, this environment underscores the value of balance and patience. With leadership concentrated in a narrow group of stocks, broad diversification remains the most reliable way to participate in the market’s strengths while managing its risks. We will continue to monitor developments closely and remain ready to act thoughtfully on your behalf. As always, we are grateful for your continued trust and wish you and your families a wonderful fall season.