The third quarter was steady on the surface and much rougher underneath. Stocks ended the quarter higher, but the gains came from a small group of companies. Meanwhile, bonds had one of their hardest stretches in years.

The Quarter in Review

According to Morningstar, the S&P 500 gained 2.03% for the quarter, the Nasdaq rose 2.47%, and the Dow fell 2.7%. The headline number hides how narrow the market was. An equal-weighted version of the S&P 500, which gives every company the same weight, actually fell about 1.5%, so the index’s gain depended on technology stocks. Only about a quarter of S&P 500 stocks were trading above their 50-day moving averages at the end of September.

The main support was earnings. Analysts expect S&P 500 earnings for the third quarter to grow about 29% from a year ago, which would make three quarters in a row above 25%. Chipmakers and their suppliers are expected to lead, with projected earnings growth over 100%.

The main pressure was energy and interest rates. The Strait of Hormuz remained closed throughout the quarter, and Brent crude rose about 42% to roughly $103 a barrel. Higher oil prices kept inflation elevated. On September 16, the Federal Reserve raised its target rate by a quarter point to 3.75%–4.00%. This was its first increase since 2023, and the Fed described inflation as still elevated.

Year to Date

It has been a year of sharp swings. The S&P 500 fell about 5% in the first quarter after the Iran conflict began, rallied about 15% in the second quarter, and added 2% in the third. That leaves it up nearly 12% for the year. The rally has been driven by earnings rather than optimism. The index’s forward price-to-earnings ratio actually fell during the year, from about 22 to about 20 by midyear.

Bonds have had a much harder year. The 10-year Treasury yield has risen from below 4% in March to about 5.29% at quarter-end, its highest level since 2002. Rising yields reduce bond prices in the short run. They also mean new money and reinvested interest now earn the best rates we have seen in decades.

What to Watch

• Oil and the Middle East. Energy prices are the biggest driver of inflation right now. Any progress toward reopening shipping lanes would help both stocks and bonds.
• The Fed. The Fed’s projections suggest another hike may come before year-end. Markets are split between a pause and another increase at the October 27–28 meeting.
• Market breadth. When a handful of companies carry the index, results become sensitive to those few names. Small-cap stocks have dropped almost 10% from their mid-August high as yields climbed. This is a good argument for staying diversified.

Midterm Elections

Midterm years have historically been choppy. The average decline within a midterm year has been about 19%, deeper than in other years of the presidential cycle. This year has followed that pattern, with a sharp spring selloff. History has generally been kinder once the vote is over. Since 1950, the S&P 500 has risen in about 84% of midterm-year fourth quarters, with an average gain of 6.6%. One year after a midterm election, the index has averaged a gain of about 15%. Much of that rebound comes from uncertainty going away, whichever party wins. Divided government, which is common after midterms, has historically been fine for markets.

None of this is a guarantee. Election patterns are much less important than earnings, inflation, and interest rates. They are a reminder that short-term volatility around elections has rarely been a good reason to change a long-term plan.

This letter is for informational purposes only and does not constitute personalized investment advice. Index performance is provided for illustrative purposes; you cannot invest directly in an index. Past performance does not guarantee future results.