Quarterly Market Update: Solid Fundamentals Meet Higher Oil and Rates

The third quarter put two forces against each other. On one side, the economy and corporate earnings stayed solid. On the other, oil and interest rates pushed back. Oil climbed back above $100 per barrel, inflation stayed elevated, Treasury yields surged, and the Federal Reserve raised rates in September.

The S&P 500 still finished higher and set a new all-time high, carried by strong earnings and steady economic activity. But the headline gain didn’t tell the whole story. Beneath it, market leadership narrowed as smaller companies and rate-sensitive areas lagged.

Artificial intelligence, meanwhile, kept playing a large role in both the economy and the markets. In this letter, we’ll look at the forces pushing interest rates higher, the economic and earnings strength helping offset that pressure, and how AI’s influence now reaches everyday borrowing costs, business investment, and the stock market.

Oil Stays Volatile, and the Fed Hikes

Oil was once again one of the quarter’s main drivers. Its sharp swings carried implications well beyond energy, touching inflation, interest rates, and economic growth.

The top chart in Figure 1 graphs the monthly change in oil prices this year, and what stands out is how often prices have changed direction.

Oil surged early in the year, fell sharply in May and June, then reversed higher again in Q3, jumping 22% in July alone. The point isn’t any single monthly move. It’s how frequently the direction has flipped.

Most of that volatility traces back to shifting expectations for Middle East oil supplies and the uncertainty around the Strait of Hormuz. And those swings matter well beyond the energy market.

That’s because oil feeds into gasoline and transportation costs, those costs feed into inflation, and inflation ultimately shapes the outlook for interest rates and growth. When oil fell in Q2, some of that pressure eased. When prices climbed again in Q3, concerns about inflation and the path of rates came right back.

That shift had a real impact on the rate outlook. Earlier in the year, investors were focused on how much the Fed could lower rates. But as oil rebounded and inflation stayed above the Fed’s target, the conversation gradually turned to whether policymakers would need to raise rates instead.

The bottom chart in Figure 1 shows how that played out. The Fed cut rates by a cumulative 1.75% beginning in September 2024, then held steady for most of this year. After a nine-month pause, it raised rates 0.25% in September, its first increase since 2023.

Markets now expect additional hikes in the coming quarters, although those expectations have shifted often this year. The broader point is that the path for rates remains closely tied to how inflation, oil, and economic growth develop into year-end and early 2027.

Earnings and Growth Hold the Line

So far, that sounds like a difficult backdrop. And in some ways, it was. Yet the underlying data told a steadier story. Corporate earnings stayed strong, and households and businesses kept spending, giving the stock market real fundamental support through the quarter’s uncertainty.

The top chart in Figure 2 graphs the year-over-year growth rate of S&P 500 earnings going back to 2001. Over the past year, 12-month earnings for the S&P 500 grew nearly 30%.

Outside of the rebounds that followed the financial crisis and COVID, that’s one of the strongest stretches of earnings growth on the chart, and a significant step up from the single-digit pace of 2023 and 2024. So while the macro backdrop was volatile, corporate profits kept growing at a strong pace.

The bottom chart looks beneath headline GDP to show what households and businesses were actually doing. Headline GDP includes volatile categories such as trade, inventories, and government spending. Final sales to private purchasers, on the other hand, focuses on consumer spending and private investment.

Comparing the two helps separate changes in the underlying economy from temporary swings. In the second quarter, headline GDP grew at a 2.2% annualized rate, down from 2.5% in Q1. Underlying private demand, however, grew 4.6%. That gap suggests households and businesses were still spending and investing at a healthy pace, even as the broader backdrop grew more volatile.

Taken together, the two charts help explain how markets absorbed the quarter’s volatility. Consumers are still spending, businesses are still investing, and earnings are still strong. That combination has served as a counterweight to higher oil prices, persistent inflation, and rising interest rates.

AI’s Reach Keeps Widening

Which brings us to the theme running through much of the year. Artificial intelligence has been a major market story for several years. What’s changed is the scale of the buildout, which is making AI more important to the broader economy and financial markets. Figure 3 shows three ways its influence is expanding: business investment, the stock market, and financing.

Start with business investment. The top chart graphs spending on data-center construction and computer equipment, which together serve as a proxy for the physical infrastructure being built to support AI.

Combined investment has grown from roughly $180 billion at the end of 2023 to nearly $490 billion today. That makes AI-related infrastructure an important source of business investment in its own right.

Next is the stock market. The middle chart shows that Technology now makes up nearly 40% of the S&P 500, up from about 34% at the end of 2025.

As that share has grown, the index has become more sensitive to the performance of its largest sector. What this means is that strong AI-related earnings and stock gains can have an outsized influence on the broader index.

And then there’s financing. Major U.S. tech companies remain highly profitable, but the scale of their AI investment programs has grown quickly. The bottom chart shows that several of these companies are increasingly turning to the bond market to help fund the buildout. Historically, the group was fairly balanced between issuing new debt and paying it down. The right side of the chart, though, shows a significant jump in new issuance.

The question isn’t just how much is being spent on AI anymore. It’s how far that spending now reaches. The buildout is supporting business investment, drawing on the bond market for financing, and carrying more weight in the stock market, all at the same time.

AI has moved well beyond a narrow technology theme, and its growing scale means it’s now influencing several parts of the economy and financial markets at once.

Equity Market Recap: Leadership Narrows as Rates Rise

The S&P 500 finished Q3 higher and set a new all-time high, but the path there was uneven, and the divergence beneath the index grew as the quarter went on.

Stocks faced some early pressure before rebounding in August, when the Russell 2000, the Dow Jones, and the equal-weight S&P 500 each set new highs. From there, leadership narrowed as larger companies outpaced smaller ones into quarter-end.

The S&P 500 gained 2.3% for the quarter, compared with 0.6% for the Nasdaq 100, -1.5% for the Dow Jones, and -6.9% for the Russell 2000. Most of that gap opened up in the second half of the quarter, which overlapped with a sharp rise in Treasury yields.

The timing suggests rising rates contributed to the divergence. That’s because smaller companies tend to be more sensitive to borrowing costs.

Sector performance reflected many of the quarter’s main themes. Only four of the eleven S&P 500 sectors outperformed the broad index, a sign of narrow breadth. Energy led with a 17.2% gain as oil climbed from roughly $70 per barrel in early July to more than $100 by mid-September.

That’s a sharp reversal from Q2, when Energy was the worst-performing sector as oil prices fell. Technology came in second with a 7.2% gain, followed by Health Care at 6.5% and Communication Services at 3.6%. On the other end, Utilities fell -12.4% as rates rose, while Industrials dropped -9.7% and Real Estate declined -5.6%.

International markets were relatively quiet after their gains in the first half of the year. Developed and emerging market stocks each finished the quarter within 1% of where they started, with developed modestly ahead of emerging.

Even so, both regions are up year-to-date and are still outperforming the S&P 500 over the past 12 months.

All told, the quarter left a mixed picture beneath the major indexes. The S&P 500 reached a new high, while smaller companies and several rate-sensitive areas moved lower as yields rose late in the quarter.

Leadership is narrower now than it was in August, though the major U.S. equity indexes remain higher year-to-date.

Credit Market Recap: Rising Rates Weigh on Bonds

The same rise in yields that pressured smaller stocks made Q3 a challenging quarter for bonds. Figure 4 graphs the change in Treasury yields across maturities during the quarter, and yields rose at every one. The 5-year, 7-year, and 10-year yields each climbed more than 0.80%, and the 30-year rose nearly 0.70%.

Longer-maturity bonds underperformed because they’re more sensitive to changes in interest rates. Shorter-maturity Treasuries held up better on a relative basis, though they still traded lower.

Corporate bonds came under pressure too, although they outperformed government bonds. High-yield posted a total return of -1.8%, ahead of investment-grade’s -3.7%. Investment-grade took the bigger hit because its longer maturities made it more sensitive to rising rates.

For most of the quarter, though, the main headwind was rising interest rates, not weakening credit conditions. Investment-grade and broad high-yield spreads stayed relatively stable and tight by historical standards, suggesting investors remained comfortable with corporate fundamentals even as borrowing costs climbed.

The clearest sign of caution showed up at the lowest-quality end of the high-yield market. Spreads on CCC-rated bonds, the lowest-rated tier of high-yield, widened even as spreads on higher-quality high-yield bonds held steady. In other words, investors started demanding more compensation to hold the debt of financially weaker borrowers. Broader high-yield spreads, which had been comparatively calm for most of the quarter, also began to widen in late September.

The market grew more selective as the quarter went on, and the impact of higher financing costs showed up first among the most sensitive borrowers.

Put simply, Q3’s weakness in bonds came mainly from rising Treasury yields, not a broad deterioration in corporate credit.

The late-quarter widening was concentrated among the lowest-quality borrowers, while investment-grade and broader high-yield spreads stayed relatively contained. Higher financing costs were creating pressure in pockets of the market, not across all of it.

2026 Outlook: What to Watch in Q4

Economic growth and corporate earnings remain strong heading into the fourth quarter, even as higher oil prices and interest rates have made the backdrop more mixed and volatile.

One of the main questions now is whether that underlying strength holds up as households and businesses adjust to higher borrowing costs, persistent inflation pressure, and continued uncertainty around energy prices.

So far, the economy has handled those pressures relatively well. Consumers have kept spending, businesses have kept investing, and unemployment has stayed low.

Those trends have supported growth even as rates and borrowing costs moved higher.

The coming months will show whether that momentum continues, particularly in the data tracking consumer spending, hiring, and business investment.

Corporate earnings will be another important source of information. Profit growth has been strong over the past year and has given the market fundamental support through a volatile macro backdrop.

Third-quarter earnings season, which begins in October, will offer an updated look at how companies are managing higher interest rates, changing input costs, and continued investment while still growing revenue and profits.

The AI investment cycle will remain part of the discussion as well. Spending on data centers, computing equipment, and related infrastructure continues to support business investment, and large technology companies are increasingly using the bond market to help pay for it.

As the cycle matures, the focus is likely to broaden from how much is being spent to what that investment is producing in revenue, profits, and productivity.

Markets have absorbed several changes this year without losing the support of economic growth and corporate earnings. We’ll continue watching how these trends develop, while keeping the focus on portfolio diversification, discipline, and meeting your long-term financial goals across a range of possible outcomes.